An investor is contemplating the purchase of common stock at the beginning of this year and to hold the stock for one year. The investor expects the year-end dividend to be $2.00 and expects a year-end price for the stock of $40. If this investor's required rate of return is 10%, then the value of the stock to this investor is
A) $36.36.
B) $38.18.
C) $33.06.
D) $34.88.

Question

Quizplus · Accepted Answer

To find the value of the stock, we can use the dividend discount model:

V0 = (D1 / (1+r)) + (P1 / (1+r))

where V0 is the current (beginning of the year) value of the stock, D1 is the expected dividend at the end of the year, P1 is the expected price of the stock at the end of the year, and r is the required rate of return.

Plugging in the values:

V0 = (2.00 / (1+0.10)) + (40 / (1+0.10)) 
V0 = 1.82 + 36.36 
V0 = 38.18

Therefore, the value of the stock to this investor is $38.18.

An Investor Is Contemplating the Purchase of Common Stock at the Beginning