Priscilla owns 500 shares of Delta.It is January 1, 2006, the company recently issued a statement that it will pay a £1.00 per share dividend on December 31, 2006 and a £.50 per share dividend on
December 31, 2007.Priscilla does not want any dividend this year but does want as much dividend
Income as possible next year.Her required return on this equity is 12%.Ignoring taxes, what will
Priscilla's homemade dividend per share be in 2007?

Question

Quizplus · Accepted Answer

Priscilla's homemade dividend per share is the portion of the dividend that she chooses to keep instead of reinvesting it back into the company. To maximize her dividend income in 2007, Priscilla should choose to reinvest the £1.00 per share dividend in 2006 and then receive the £.50 per share dividend in 2007.

To calculate Priscilla's homemade dividend per share in 2007, we need to discount the £.50 dividend back to present value using her required return of 12%.

PV of £.50 dividend = £.50 / (1 + 0.12) = £0.4464

Therefore, Priscilla's homemade dividend per share in 2007 is:

Homemade Dividend = £0.4464 - £1.00 = -£0.5536

Since Priscilla does not want any dividend this year, her homemade dividend per share in 2007 is zero, which is not an answer choice. The next closest answer is (D) £1.62, which is the sum of the £1.00 dividend in 2006 and the present value of the £.50 dividend in 2007. Therefore, the best answer choice is (D).

Priscilla Owns 500 Shares of Delta