Northern Railways has a current stock price of $56.75 and is expected to pay a dividend of $1.15 in one year.If Northern's equity cost of capital is 12%,what price would Northern's stock be expected to sell for immediately after it pays the dividend?

Question

Quizplus · Accepted Answer

The stock price immediately after the dividend payment can be calculated using the formula:
P = (D / (r - g))
where,
P = price of the stock
D = expected dividend payment
r = equity cost of capital
g = expected dividend growth rate

Here, D = $1.15, r = 12%, and g = 0 (since no growth is mentioned in the question).

Thus, P = (1.15 / (0.12 - 0)) = $9.58

This means that the theoretical ex-dividend price of the stock would be $56.75 - $1.15 = $55.60. Therefore, the expected price immediately after the dividend payment would be $9.58 higher, which is $65.18.

However, since the answer choices do not include this value, we can use approximation. Choice (C) is nearest to this value, so it is the best choice.

Northern Railways Has a Current Stock Price of $56