Suppose the dividend paid on a share takes one of four values, each with equal probability: $0.00, $0.08, $0.28 and $0.60. The share trades for 15 periods. The prevailing market interest rate is 10%. If you wanted to implement a flat fundament value for this share then you should set that fundamental value equal to:
A) $0.24.
B) $3.60.
C) $0.024.
D) $2.40.

Question

Quizplus · Accepted Answer

The expected dividend per period is the average of the possible dividends: (0 + 0.08 + 0.28 + 0.60) / 4 = 0.24. The fundamental value is the present value of these expected dividends over 15 periods at a 10% interest rate. The formula for the present value of an annuity is used: PV = D * [(1 - (1 + r)^-n) / r], where D is the expected dividend, r is the interest rate, and n is the number of periods. Plugging in the values: PV = 0.24 * [(1 - (1 + 0.10)^-15) / 0.10] ≈ $2.40.

Suppose the Dividend Paid on a Share Takes One of Four