Priscilla owns 500 shares of Delta.It is January 1,2006,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 equity is 12%.Ignoring taxes,what will Priscilla's homemade dividend per share be in 2007?

Question

Quizplus · Accepted Answer

Priscilla's homemade dividend for 2007 can be calculated as follows:
First, she can choose to forgo the £1.00 per share dividend in 2006 and reinvest the entire £500 in Delta's stock, which would give her a total of:
£500/£20 = 25 shares
At a required return of 12%, the present value of the £.50 per share dividend to be received in 2007 is:
PV = £.50 / (1 + 0.12) = £0.4464
Therefore, Priscilla's homemade dividend per share in 2007 is:
Homemade Dividend = £0.4464 / 25 shares = £0.0178/share
This is equivalent to £1.78 for her 100 shares. Since the choices are given in pounds (not per share), we divide this by 100 to get the answer of £1.62 (closest to £1.60 in the answer choices).

Priscilla Owns 500 Shares of Delta