You are evaluating the purchase of Cellars Pty Ltd ordinary shares 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 shares for three years and then sell them.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.

Question

Quizplus · Accepted Answer

The present value of the expected dividends can be calculated using the formula for the present value of a growing annuity. The dividends are expected to grow at a rate of 12% for the next three years. 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, discounted at the required rate of return of 17.5%, is calculated as follows: PV = $2.016 / (1 + 0.175) + $2.25792 / (1 + 0.175)^2 + $2.52907 / (1 + 0.175)^3 = $1.715 + $1.630 + $1.566 = $4.911 This rounds to $4.91, making option A the correct answer.

You Are Evaluating the Purchase of Cellars Pty Ltd Ordinary