You own 1,000 shares of stock in ABC Corporation. You will receive a 60 cent per

Question

You own 1,000 shares of stock in ABC Corporation. You will receive a 60 cent per share dividend in one year. In two years, ABC will pay a liquidating dividend of $30 per share.The required return on ABC stock is 15%. What is the current share price of your stock (ignoring taxes)? If you would rather have equal dividends in each of the next two years, show how you can accomplish this by creating homemade dividends.
(Hint: Dividends will be in the form of an annuity.)

Suppose you want only $200 total in dividends the first year. What will your homemade dividend be in two years?                                                                      (10 marks)

Explanation / Answer

You own 1,000 shares of stock in ABC Corporation. You will receive a 60 cent per share dividend in one year. In two years, ABC will pay a liquidating dividend of $30 per share.The required return on ABC stock is 15%. What is the current share price of your stock (ignoring taxes)?

Current share price of your stock = 0.60/1.15 + 30/1.15^2

Current share price of your stock = $ 23.21

If you would rather have equal dividends in each of the next two years, show how you can accomplish this by creating homemade dividends.
(Hint: Dividends will be in the form of an annuity.)

Current Stock price = Homemade dividends per share/1.15 + Homemade dividends per share /1.15^2

23.21 = Homemade dividends per share (1/1.15 + 1/1.15^2)

Homemade dividends per share= 23.21*1.15^2/2.15

Homemade dividends per share= $ 14.28

Suppose you want only $200 total in dividends the first year. What will your homemade dividend be in two years?    

Current Stock price = 0.20/1.15 + Homemade dividends in year 2 per share /1.15^2

Homemade dividends in year 2 per share =( 23.21 - 0.20/1.15 )*1.15^2

Homemade dividends in year 2 per share = 30.46523

Answer

Total Homemade dividends in year 2 = $ 30,465.23

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