You want to invest in a stock that pays $6.00 annual cash dividends for the next ﬁve years. At the end of the ﬁve years, you will sell the stock for $30.00. If you want to earn 10% on this investment,
What is a fair price for this stock if you buy it today?

Question

Quizplus · Accepted Answer

To calculate the fair price of the stock, we need to use the discounted cash flow (DCF) method. The formula for DCF is:

Fair Price = (dividend payment / (1 + discount rate)^year) + (selling price / (1 + discount rate)^year)

Plugging in the numbers from the problem, we get:

Fair Price = (6 / (1 + 0.1)^1) + (6 / (1 + 0.1)^2) + (6 / (1 + 0.1)^3) + (6 / (1 + 0.1)^4) + (6 / (1 + 0.1)^5) + (30 / (1 + 0.1)^5)
Fair Price = $41.37

Therefore, the best choice is A, as it is the fair price for the stock based on our calculation.

You Want to Invest in a Stock That Pays $6