Priscilla owns 500 shares of Delta stock. It is January 1,2006,and the company recently issued a statement that it will pay a $1.00 per share dividend on December 31,2006 and a $.50 per share dividend on December 31,2007. Priscilla does not want any dividend this year but does want as much dividend income as possible next year. Her required return on this stock is 12%. Ignoring taxes,what will Priscilla's homemade dividend per share be in 2007?

Question

Quizplus · Accepted Answer

Homemade dividend is the concept of creating one's own dividend by selling a portion of the stock. Here, Priscilla wants to maximize her dividend income in 2007.

To do so, she can create homemade dividend by selling a portion of her stock in 2006 in order to reduce her holdings to a level that would generate a $.50 per share dividend in 2007.

The formula to calculate the number of shares to sell is:

Homemade Dividend = (Required Dividend - Actual Dividend) / Required Return

= ($.50 - $0) / 12%

= 4.17 shares.

Therefore, Priscilla should sell 4 shares (as she can't sell a part of a share) in 2006, which will reduce her holdings to 496 shares.

So, her homemade dividend per share in 2007 will be:

Homemade Dividend = $0.50  (given)

Therefore, the total dividend income she will receive in 2007 will be:

Total Dividend Income = Homemade Dividend * Number of Shares + Actual Dividend * Number of Shares

= ($0.50 * 496) + ($0 * 4)

= $248.

Hence, the answer is D ($1.62).

Priscilla Owns 500 Shares of Delta Stock