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Suppose Acap Corporation will pay a dividend of $2
Suppose Acap Corporation will pay a dividend of $2.84 per share at the end of this year and $2.96 per share next year. You expect Acap's stock price to be $51.67 in two years. Assume that Acap's equity cost of capital is 10.6%. a. What price would you be willing to pay for a share of Acap stock today, if you planned to hold the stock for two years? b. Suppose instead you plan to hold the stock for one year. For what price would you expect to be able to sell a share of Acap stock in one year? c. Given your answer in (b), what price would you be willing to pay for a share of Acap stock today if you planned to hold the stock for one year? How does this compare to your answer in (a)? a. What price would you be willing to pay for a share of Acap stock today, if you planned to hold the stock for two years? If you plan to hold the stock for two years, the price you would pay for a share of Acap stock today is $ (Round to the nearest cent.)
Expert Solution
a.
Dividend received this year (D1) =2.84
Dividend received next year (D2) =2.96
Sell price of stock in year 2 (P2) =51.67
Required return (ke) =10.6%
Price of stock today is present value of future cash flows received by us.
Price of stock = (D1/(1+ke)^1) + ((D2+P2)/(1+ke)^2)
=(2.84/(1+10.6%)^1) + ((2.96+51.67)/(1+10.6%)^2)
=47.228041032
So we would be willing to pay 447.23 for stock today.
b.
Price of stock in 1 year is present value of future cash flows received that is present value of dividends in year 2 and price of stock in year 2.
Number of years gap at that time will be 1 year from 1 year
Price of stock in 1 year = (D2+P2)/(1+ke)^1
=((2.96+51.67)/(1+10.6%)^1)
=49.394213382
So we would be able to sell the stock for $49.39 in 1 year
c.
If we hold stock for 1 year then price of stock today is present value of dividends and price of stock received in 1 year
Price of stock today = (D1+P1)/(1+ke)^1
=(2.84+49.394213382)/(1+10.6%)^1
=47.228041033
So we would be willing to pay $47.23 for stock.
Answer to part a and part c is same. This is because that stock price is present value of future cash flows received on stock. It does not make any difference that whether we hold stock for 1 year or 2 year or more, price of stock will be same.
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