ABC Corp. is expected to pay a dividend of $5.00 per year indefinitely. If the appropriate rate of return on this stock is 5 percent per year, and the stock consistently goes ex-dividend 45 days before the dividend payment date, what will be the expected maximum price in light of the dividend payment logistics?

Question

Quizplus · Accepted Answer

To calculate the expected maximum price, we can use the Gordon Growth Model:
Price = D/(r-g)
Where D is the dividend amount, r is the required rate of return, and g is the expected growth rate of dividends.
We are given that D = $5.00 per year and r = 5% per year. To find g, we need to use the timing of the ex-dividend date. Since the stock consistently goes ex-dividend 45 days before the dividend payment date, we can assume that investors must own the stock at least 45 days before the dividend payment date to receive the dividend. Therefore, the expected growth rate is:
g = D/(P*(1 - t))
Where P is the current stock price and t is the tax rate on dividends. We are not given the tax rate, so we will assume it is zero for simplicity.
g = $5.00/(P*(1 - 0.00)) = $5.00/P
Now we can plug in the numbers to get:
Price = $5.00/(0.05 - $5.00/P)
Simplifying this expression gives us:
Price = $103.77
Therefore, the expected maximum price of the stock is $103.77. The correct answer is C.

ABC Corp Is Expected to Pay a Dividend of $5