You want to invest in a stock that pays $4.00 annual cash dividends for the next three years.At the end of the three years,you will sell the stock for $35.00.If you want to earn 9% on this investment,what is a fair price for this stock if you buy it today?

Question

Quizplus · Accepted Answer

We can use the formula for present value of a stock with constant dividend and a selling price at the end: 
PV = (D/R) * (1 - 1/(1+R)^n) + SP/(1+R)^n
PV = (4/0.09) * (1 - 1/(1+0.09)^3) + 35/(1+0.09)^3
PV = 10.4669 + 26.6848
PV = $37.15
Therefore, the fair price for this stock today is $37.15, and the best choice is B.

You Want to Invest in a Stock That Pays $4