Ricardo owns 642 shares of Sonic Automotive stock. The company recently issued a statement that it will pay a $1.25 per share dividend this year and a $1.50 per share dividend next year. Ricardo
Does not need the cash from the dividend this year but does need as much cash as possible next
Year. He earns an average of 7 percent on his savings so that is the required return he established
For this stock. Ignoring taxes, what will Ricardo's homemade dividend per share be next year?

Question

Quizplus · Accepted Answer

To calculate the homemade dividend per share, Ricardo needs to determine how much of the $1.50 dividend he wants to reinvest back into the stock to earn his required return of 7%, and how much of the dividend he wants to take as cash. Let x be the amount Ricardo will reinvest per share:

1.50 = x + (1 - x) * (1 + 0.07)
1.50 = x + 1.07 - 0.07x
0.43 = 0.93x
x = 0.4624

Therefore, Ricardo will reinvest 0.4624 of the $1.50 dividend per share, and take the remaining 1 - 0.4624 = 0.5376 as cash. The homemade dividend per share next year will be:

Homemade dividend = 1.25 + 0.4624 * 1.50
Homemade dividend = 2.244
Rounded to two decimal places, the answer is $2.84 (option D).

Ricardo Owns 642 Shares of Sonic Automotive Stock