The Lighthouse Co.is in a downsizing mode.The company paid a €2.50 annual dividend last year.The company has announced plans to lower the dividend by €.50 a year.Once the dividend amount becomes zero,the company will cease all dividends permanently.The required rate of return is 16%.What is one share of this equity worth?

Question

Quizplus · Accepted Answer

The correct answer is A because the present value of the dividends is €3.76. The present value of the dividends is calculated as follows:PV = D1 / (r - g) + D2 / (r - g)^2 + ... + Dn / (r - g)^nwhere:PV is the present value of the dividendsD1 is the dividend in year 1r is the required rate of returng is the growth rate of the dividendsn is the number of yearsIn this case, the dividend in year 1 is €2.50, the required rate of return is 16%, and the growth rate of the dividends is -€0.50 per year. The number of years is infinite because the company will cease all dividends permanently once the dividend amount becomes zero.Therefore, the present value of the dividends is:PV = €2.50 / (0.16 - (-€0.50)) = €3.76