You want to invest in a stock that pays $2.00 annual cash dividends for the next four years. At the end of the four years, you will sell the stock for $27.00. If you want to earn 11% on this investment, what is a fair price for this stock if you buy it today?

Po = D1 + D2 + D3 + D4 + P4

(1 + K) (1 + K) 2 (1 + k) 3 (1 + K) 4

Po = $2.00 + $2.00 + $2.00 + $2.00 + $27.00

(1 + 0.11) (1 + 0.11) 2 (1 + 0.11) 3 (1 + 0.11) 4

Po = $2.00 + $2.00 + $2.00 + $29.00

(1.11) (1.11) 2 (1.11) 3 (1.11) 4

Po = $1.80 + $1.62 + $1.46 + $19.10

Po = $23.98

Explanation:

The current market price of the stock is a function of dividend in year 1 divided by 1 + r plus the dividend in year 2 divided by 1 + r raised to power 2 plus dividend in year 3 divided by 1 + r raised to power 3 plus the aggregate of dividend and market price in year 4 divided by 1 + r raised to power 4. r denotes required return on stock.