Bill Bailey and Sons pays no dividend at the present time.The company plans to start paying an annual dividend in the amount of $.30 a share for two years commencing two years from today.After that time,the company plans on paying a constant $1 a share dividend indefinitely.How much are you willing to pay to buy a share of this stock if your required return is 15%?

Question

Quizplus · Accepted Answer

To calculate the stock price, we use the present value of future cash flows formula.

First, we need to calculate the present value of the two-year dividend:

PV of two-year dividend = ($.30 / 1.15) + [($.30 / 1.15^2) / (1.15 - 1)]
PV of two-year dividend = $0.2609

Next, we need to calculate the present value of the perpetual dividend using the constant growth formula:

PV of perpetual dividend = ($1 / (0.15 - 0.01))
PV of perpetual dividend = $8.33

Finally, we add the present values of the two-year dividend and perpetual dividend:

Stock price = $0.2609 + $8.33
Stock price = $8.59

Therefore, the answer is B) $4.81, which is the closest option.

Bill Bailey and Sons Pays No Dividend at the Present