You own 2,000 shares of stock in JCC Corporation

Solution

(a).

Current Price =Present Value of future Cash flows

Present Value of future cash flow=(Cash flow)/((1+i)^N)

i=discount rate =required return =10%=0.1

N=Year of Cash flow

Dividend in year 1=D1=$7.36

Present Value of dividend D1 =7.36/(1+0.1)=$6.69

Liquidating dividend in year 2=D2=$65

Present Value of liquidating dividend D2 =65/((1+0.1)^2)=$53.72

Current Price =6.69+53.72=$60.41

(b).

If Bob prefers to have equal dividend in two years,

D2=D1=D

D/1.1+D/(1.1^2)=60.41

0.909091D+0.826446D=60.41

1.735537 D=60.41

D=60.41/1.735537=$34.81

(c)

The Price of stock equals Present Value of all the future cash flows.If dividend is not paid now, the profit goes into the retained earnings which increases future cash flows.As per dividend irrelevance theory,investors need not bother about the company's dividend policy. The earnings belong to the shareholders either in the form of dividend or retained earnings(capital appreciation).

Investors can sell part of their holding if they need cash and dividend is insufficient.

Company's dividend payment policy have no impact on the company's stock price.

As , we have seen in the above example, Stock price is $60.41. Dividend may be equal in two years or it may vary in two years.