Chapter 9, Problem 1P

Assume Evco, Inc., has a current price of $50 and will pay a $2 dividend in one year, and Its equity cost of capital is 15%. What price must you expect it to sell for right after paying the dividend in one year in order to justify its current price?

Summary Introduction

To determine: The expected selling price after paying dividend

Introduction:

A bond is a debt instrument with which the shareholder credits cash to an entity; it can be a government or an organization that scrounges finance for a distinct timeframe at a pre-defined interest rate. Coupon rate is expressed as an interest rate on a fixed income security, similar to a bond. It is also called as the interest rate that the bondholders get from their investment. It depends on the yield as on the day the bond is issued.

Answer to Problem 1P

Expected selling price after paying one year dividend is $55.50

Explanation of Solution

Explanation

Calculation of the expected selling price after paying dividend

It is given that current price is $50, dividend is $2 in one year, and the cost of capital is 15%

$\begin{array}{c}\text{Current}\text{price}=\frac{\text{Dividend}+\text{Expected}\text{price}}{\left(\text{1+}\text{Cost}\text{of}\text{capital}\right)}\\ \$50=\frac{\$2+\text{Expected}\text{price}}{\left(1+15\%\right)}\\ \$2+\text{Expected}\text{price}=\$50\times \left(1.15\right)\\ \$2+\text{Expected}\text{price}=\$57.5\\ \text{Expected}\text{price}=\$57.5-\$2\\ \text{Expected}\text{price}=\$55.5\end{array}$

Therefore, the expected selling price after paying one year dividend is $55.5.