Valorous Corporation will pay a dividend of $1.80 per share at this year's end and a dividend of $2.40 per share at the end of next year.It is expected that the price of Valorous' stock will be $44 per share after two years.If Valorous has an equity cost of capital of 8%,what is the maximum price that a prudent investor would be willing to pay for a share of Valorous stock today?

Question

Quizplus · Accepted Answer

To determine the maximum price a prudent investor would be willing to pay today, we need to find the present value of all future cash flows of Valorous Corporation.

Using the dividend discount model:

PV = D1/(1 + r) + D2/(1 + r)^2 + P/(1 + r)^2

Where: 
D1 = dividend at the end of this year = $1.80 
D2 = dividend at the end of next year = $2.40 
P = expected price of stock after two years = $44 
r = equity cost of capital = 8% or 0.08

Substituting the values:

PV = 1.80/(1 + 0.08) + 2.40/(1 + 0.08)^2 + 44/(1 + 0.08)^2

PV = 1.67 + 2.11 + 30.67

PV = 34.45

Therefore, the maximum price a prudent investor would be willing to pay for a share of Valorous stock today is $41.45.

Option C is the correct answer.

Valorous Corporation Will Pay a Dividend of $1