A) Shearon Harris Corporation has just paid a $2.00 per share dividend for the y

Question

A) Shearon Harris Corporation has just paid a $2.00 per share dividend for the year.The stock presently sells for $20 per share. Furthermore, you have made thefollowing assumptions. In doing some research, you have found that thisrepresents a 5 percent growth in the dividend from the previous year. This growthrate is expected to continue for 3 years. In addition, you estimate that you willsell the stock in 3 years and could sell this stock in 3 years at $24.30. What is themaximum price you should pay for this company if you require a 15 percent rateof return? Should you buy the stock at the present price?

B) Suppose that you change your mind and that you will sell the stock in 5 yearsinstead at a price of $26.80. All other assumptions remain the same. What is themaximum price you should pay for this stock?

Explanation / Answer

Year 1 ($2.0 x 1.05) = $2.10

Year 2 ($2.10 x 1.05) = $2.205

Year 3 ($2.205 x 1.05) = $2.315

Present value of stock = 2.10/1.15 +2.205/1.15^2 +2.315/1.15^3+24.30/1.15^3 =20.99 =20.9932

Year 1 ($2.0 x 1.05) = $2.10

Year 2 ($2.10 x 1.05) = $2.205

Year 3 ($2.205 x 1.05) = $2.315

Year 4 ($2.315 x 1.05) = $2.431

Year 5 ($2.431 x 1.05) = $2.552

Present value of stock

= 2.10/1.15 +2.205/1.15^2 +2.315/1.15^3+2.431/1.15^4+2.552/1.15^5+26.80/1.15^5 =20.99 =20.9986

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