An investor wishes to hold a stock for 1 year. If the stock is expected to pay a $15 dividend and sell for $300 in one year from now,the investor will buy the stock if

Question

Quizplus · Accepted Answer

To determine if the investor should buy the stock, we need to calculate the present value of the future cash flows (the dividend and the sale price) and compare it to the current stock price.

Using the formula for present value: PV = FV / (1 + r)^n where PV is the present value, FV is the future value, r is the required rate of return, and n is the time period.

PV of the dividend = $15 / (1 + r)^1
PV of the sale price = $300 / (1 + r)^1

The total present value of the stock is the sum of the present values of the dividend and sale price: 
Total PV = ($15 / (1 + r)^1) + ($300 / (1 + r)^1) = $315 / (1 + r)^1

We can then compare this total present value to the current stock price to determine if the investor should buy the stock.

For choice B, the required rate of return is 12%, so the total present value of the stock is: 
Total PV = $315 / (1 + 0.12)^1 = $281.25

If the current stock price is below $281.25, then the investor should buy the stock because it is undervalued.

Therefore, the best choice is B.

An Investor Wishes to Hold a Stock for 1 Year