Bierce Company stock is not paying any dividend at present. However, you feel th

Question

Bierce Company stock is not paying any dividend at present. However, you feel that it may start paying an annual dividend of $1 after one year (probability is 30%). If it does not start the dividend after one year then it may start the dividend after two years, with a probability of 50%. It will certainly start paying dividends after three years. Once the dividend start, they will continue uniformly in the future. If your required rate of return is 15%, how much should you pay for a share of Bierce stock? Answer is $5.79 per share

Explanation / Answer

Assumed cash dividend paid in the beginning of year Details Year 1 Year 2 Year 3 Year 4 Cash Dividend                         1                      1                       1 Probability 30% (50% +30%*50%) =65% 100% Expected Dividend                 0.30                0.65                       1 Expcetd value of all dividends from Year 4                   6.7 Total Cash flows                 0.30                0.65                 7.67 Discount factor @ 15%             0.8696           0.7561            0.6575 PV of cash flows                 0.26                0.49                 5.04 Total PV $             5.79 So current value of Bierce stock = $             5.79

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