[4 Marks] AB Corp stock currently sells for $18.45 per share. The firm pays a co

Question

[4 Marks] AB Corp stock currently sells for $18.45 per share. The firm pays a constant dividend of $0.25 per year which is not expected to change for the foreseeable future. Given the risk associated with AB Corp, you believe that an appropriate rate of return for this stock is 8%.

a) [2 Marks] If you plan to hold the stock for the next four years, what would be your expected selling price for the stock?

b) [2 Marks] Suppose that the dividend and the discount rate remain constant. If the expected future price of the stock increases by $1, will the current price also increase by $1? Why or why not?

Explanation / Answer

a) [2 Marks] If you plan to hold the stock for the next four years, what would be your expected selling price for the stock?

Expected selling price for the stock = 18.45*(1+8%)^4 - 0.25*1.08 - 0.25*1.08^2 - 0.25*1.08^3 - 0.25*1.08^4

Expected selling price for the stock = $ 23.88

b) [2 Marks] Suppose that the dividend and the discount rate remain constant. If the expected future price of the stock increases by $1, will the current price also increase by $1? Why or why not?

It would not be happen because expected future price would be pooled by discount rate to compute current price , So current price will increase by lesser than $ 1. As per Time Value of Money Expected Future Value has lesser value in todays money it incorporate interest.

Related Questions

Navigate

• Browse (All)
• Browse #
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.