Elena Johnson owns 100 shares of Funky Foods,which has 100,000 shares of stock outstanding.Funky Foods is expected to earn $1 million in after-tax profits every year forever.The interest rate is 5 percent (0.05)per year.According to the principle of asset valuation,what is the value of Elena's shares?

Question

Quizplus · Accepted Answer

The value of Elena's shares can be calculated using the dividend discount model: 
Share Value = Annual Dividend / (Discount Rate - Growth Rate)
Since the company is expected to earn $1 million in after-tax profits every year, and there are 100,000 shares, the annual dividend per share is $10.
Assuming that the company will grow at a constant rate of 0%, the share value is:
Share Value = $10 / (0.05 - 0) = $200
However, since Elena only owns 100 shares, her share value is:
Share Value = $200 * 100 = $20,000
Therefore, the best choice is C, $20,000.

Elena Johnson Owns 100 Shares of Funky Foods,which Has 100,000