The Absolute Finance Company (AFC) earned $5 a share last year and paid a dividend of $2 per share. Next year, you expect AFC to earn $6 a share next year and continue its payout ratio. Assume that you expect to sell the stock for $45 a year from now. If you require a 13 percent return on this stock, how much would you be willing to pay for it?
A) $41.95
B) $43.21
C) $45.13
D) $46.72
E) $47.40

Question

Quizplus · Accepted Answer

The expected dividend next year can be calculated as follows: $6 * ($2 / $5) = $2.40. The price you would be willing to pay for the stock is the present value of the expected dividend plus the present value of the expected sale price: $2.40 / (1 + 0.13) + $45 / (1 + 0.13) = $2.12 + $39.82 = $41.95.

The Absolute Finance Company (AFC) Earned $5 a Share Last