How much would you pay for a common share today if you expect it will pay a dividend of $2.50 each year and will sell for $58 two years from now? Assume your required rate of return on this share is 13.0%.

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Quizplus · Accepted Answer

The value of the share today can be calculated using the dividend discount model for a period of two years, plus the expected sale price, all discounted back to the present value at the required rate of return. The formula for the present value (PV) of future cash flows is: PV = [D1 / (1 + r)^1] + [D2 / (1 + r)^2] + [P / (1 + r)^2], where D1 and D2 are the dividends in years 1 and 2, P is the sale price in year 2, and r is the required rate of return. Plugging in the given values: PV = [$2.50 / (1 + 0.13)^1] + [$2.50 / (1 + 0.13)^2] + [$58 / (1 + 0.13)^2] = $2.21 + $1.96 + $45.42 = $49.59.

How Much Would You Pay for a Common Share Today