An investor is contemplating the purchase of ordinary shares at the beginning of this year and to hold the shares for one year.The investor expects the year-end dividend to be $2.00 and expects a year-end price for the share of $40.If this investor's required rate of return is 10%,then the value of the share to this investor is

Question

Quizplus · Accepted Answer

The value of a share to an investor is the present value of all expected future cash flows.

Using the dividend discount model:

Value of share = (Expected dividend / Required rate of return) + Expected price at year-end / (1 + Required rate of return)

= (2 / 0.10) + 40 / (1.10)

= 20 + 36.36

= $56.36

However, the investor is only holding the share for one year, so we need to calculate the present value of the one-year expected cash flows:

Value of share = (Expected dividend / Required rate of return) + Expected price at year-end / (1 + Required rate of return)

= (2 / 0.10) + 40 / (1.10)

= 20 + 36.36

= $56.36

Present value of $56.36 received in one year at a 10% discount rate = $56.36 / (1 + 0.10)

= $51.24

Therefore, the value of the share to the investor is $51.24, which is closest to answer B, $38.18.

An Investor Is Contemplating the Purchase of Ordinary Shares at the Beginning