You are evaluating the purchase of Cellars, Inc. common stock that just paid a dividend of $1.80. You expect the dividend to grow at a rate of 12% for the next three years. You plan to hold the stock for three years and then sell it. You estimate that a required rate of return of 17.5% will be adequate compensation for this investment. Calculate the present value of the expected dividends.
A) $4.91
B) $5.40
C) $9.80
D) $6.80

Question

Quizplus · Accepted Answer

The present value of the expected dividends is calculated using the formula for the present value of a growing annuity. The dividends grow at a rate of 12% for the next three years, and the required rate of return is 17.5%. The dividends for the next three years would be: Year 1: $1.80 * (1 + 0.12) = $2.016 Year 2: $2.016 * (1 + 0.12) = $2.25792 Year 3: $2.25792 * (1 + 0.12) = $2.52907 The present value of these dividends is calculated as: PV = $2.016 / (1 + 0.175) + $2.25792 / (1 + 0.175)^2 + $2.52907 / (1 + 0.175)^3 = $1.715 + $1.631 + $1.564 ≈ $4.91

You Are Evaluating the Purchase of Cellars, Inc