You want to invest in a stock that pays $3.50 annual cash dividends for the next six years.At the end of the six years,you will sell the stock for $22.50.If you want to earn 12.5% on this investment,what is a fair price for this stock if you buy it today?

Question

Quizplus · Accepted Answer

To determine the fair price of the stock, we need to calculate the present value of all the future cash flows. The cash flows consist of six annual dividends of $3.50 each, plus the final proceeds from selling the stock, which is $22.50.

To calculate the present value, we can use the formula: PV = CF1/(1+r)^1 + CF2/(1+r)^2 + ... + CFn/(1+r)^n

Where PV is the present value, CF is the cash flow for a given year, r is the desired rate of return, and n is the number of years.

Plugging in the values we get: 
PV = 3.50/(1+0.125)^1 + 3.50/(1+0.125)^2 + ... + 3.50/(1+0.125)^6 + 22.50/(1+0.125)^6

Solving for PV yields approximately $25.29, which is closest to answer choice B.

You Want to Invest in a Stock That Pays $3