Rosebud Florists pays a constant dividend of $1.50 a share. The company announced today that it will continue to do this for another 2 years after which time it will discontinue paying dividends
Permanently. What is one share of this stock worth today if the required rate of return is 7.5%?

Question

Quizplus · Accepted Answer

To calculate the value of the stock today, we need to find the present value of the future dividends for the next 2 years and the present value of the stock at the end of year 2 when the dividends stop. Using the formula for the present value of a perpetuity:
PV = D/(r-g), where D is the dividend, r is the required rate of return, and g is the growth rate (which is zero in this case because the dividends are constant).
PV of 2 years of dividends = $1.50/(1+0.075)^1 + $1.50/(1+0.075)^2 = $2.69
PV of the stock at the end of year 2 = $1.50/(0.075-0) / (1+0.075)^2 = $15.99
Total PV = $2.69 + $15.99 = $18.68
Therefore, one share of this stock is worth $18.68 today, and the closest option is C) $2.69.

Rosebud Florists Pays a Constant Dividend of $1