Question

Suppose you are thinking of purchasing the stock of Moore Oil, Inc. You expect it to pay a $2.2 dividend in one year, and you require a return of 10% on investments of this risk. In addition to the dividend in one year, you expect a dividend of $2.40 in two years and a stock price of $14.60 at the end of year 2. Now how much would you be willing to pay?

a. $15
b. $14
c. $10
d. $11
e. $12
f. $13
g. $16
h. $17
i. $18

Answer 1

Answer:

Correct option is G

Explanation:

Since required return on investment =10%

Thus discount factor = 1.1

Present value of stock = 2.2/1.1 + (14.6 + 2.4)/1.1^2

= $16.04

Answer 2

Answer:

$16 ( g )

Explanation:

Dividend expected after 1st year = $2.2

required return on investment =10%

dividend expected in 2 years = $2.4

stock price at the end of 2 years = $14.60

discount factor  = 1.1 since required return on investment = 10%

To calculate the value of the stock

value of stock = $\frac{dividend}{discount factor} + \frac{dividend after 2years + value of stock after 2 years}{discount factor^{2} }$

value of stock =$\frac{2.2}{1.1} + \frac{14.6 + 2.4}{1.1^{2} }$

                         = 2 + 14.049

                          = $16.05