You are considering the purchase of a share of Ranch's common stock. You expect to sell it at the end of 1 year for $32.00. You will also receive a dividend of $2.50 at the end of the year. Ranch just paid a dividend of $2.25. If your required return on this stock is 12%, what is the most you would be willing to pay for it now

Question

Business

Genevieve Stanton

25 February, 22:43

You are considering the purchase of a share of Ranch's common stock. You expect to sell it at the end of 1 year for $32.00. You will also receive a dividend of $2.50 at the end of the year. Ranch just paid a dividend of $2.25. If your required return on this stock is 12%, what is the most you would be willing to pay for it now

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Philip Ramsey · Answer 1

Current dividend paid (Do) = $2.25

Dividend in 1 year's time (D1) = $2.50

Market price in 1 year's time (P1) = $32

Required return on common stock (Ke) = 12% = 0.12

Po = D1 + P1 / 1 + Ke

Po = $2.50 + $32 / 1 + 0.12

Po = $34.50/1.12

Po = $30.80

Explanation:

The current market price of the stock is a function of dividend paid in 1 year's time and market price in 1 year's time capitalised at the required return on equity.