The Red Bud Co.just paid a dividend of €1.20 a share.The company announced today that it will continue to pay this constant dividend for the next 3 years after which time it will discontinue paying dividends permanently.What is one share of this equity worth today if the required rate of return is 7%?

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Quizplus · Accepted Answer

The value of the share today can be calculated using the present value of the dividends to be received. Since the dividends are constant for the next 3 years and then cease, we can calculate the present value of each dividend and sum them up. The formula for the present value of a future payment is $PV = \frac{C}{(1 + r)^n}$, where $C$ is the cash flow (dividend), $r$ is the discount rate (required rate of return), and $n$ is the number of periods.For each of the next 3 years, the present value of the €1.20 dividend is calculated as follows:Year 1: $PV_1 = \frac{€1.20}{(1 + 0.07)^1} = €1.12$Year 2: $PV_2 = \frac{€1.20}{(1 + 0.07)^2} = €1.05$Year 3: $PV_3 = \frac{€1.20}{(1 + 0.07)^3} = €0.98$Adding these up gives the total present value of the dividends: €1.12 + €1.05 + €0.98 = €3.15.