Question

Suppose Acap Corporation will pay a dividend of

$ 2.75$2.75

per share at the end of this year and

$ 2.94$2.94

per share next year. You expect​ Acap's stock price to be

$ 53.33$53.33

in two years. Assume that​ Acap's equity cost of capital is

8.5 %8.5%.

a. What price would you be willing to pay for a share of Acap stock​ today, if you planned to hold the stock for two​ years?

b. Suppose instead you plan to hold the stock for one year. For what price would you expect to be able to sell a share of Acap stock in one​ year?

c. Given your answer in

​(b​),

what price would you be willing to pay for a share of Acap stock today if you planned to hold the stock for one​ year? How does this compare to your answer in

​(a​)?

Answer 1

Dividend in 1 year, D1 = $2.75
Dividend in 2 years, D2 = $2.94
Stock Price in 2 years, P2 = $53.33
Cost of Capital, rs = 8.50%

Answer a.

Stock Price today, P0 = D1/(1+rs) + D2/(1+rs)^2 + P2/(1+rs)^2
Stock Price today, P0 = $2.75/1.085 + $2.94/1.085^2 + $53.33/1.085^2
Stock Price today, P0 = $50.33

Answer b.

Stock Price in 1 year, P1 = D2/(1+rs) + P2/(1+rs)
Stock Price in 1 year, P1 = $2.94/1.085 + $53.33/1.085
Stock Price in 1 year, P1 = $51.86

Answer c.

Stock Price today, P0 = D1/(1+rs) + P1/(1+rs)
Stock Price today, P0 = $2.75/1.085 + $51.86/1.085
Stock Price today, P0 = $50.33

Answer is part (a) and (c) are same.