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28 April, 02:50

You want to invest in a stock that pays $4.00 annual cash dividends for the next three years. At the end of the three years, you will sell the stock for $35.00. If you want to earn 9% on this investment, what is a fair price for this stock if you buy it today?

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  1. 28 April, 03:18
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    Po = D1/1+ke + D2 / (1+ke) 2 + D3+P3 / (1+ke) 3

    Po = 4/1+0.09 + 4 / (1+0.09) 2 + 4+35 / (1+0.09) 3

    Po = 4/1.09 + 4 / (1.09) 2 + 39 / (1+0.09) 3

    Po = 3.6697 + 3.6667 + 30.1158

    Po = $37.45

    Explanation:

    The fair price is a function of future dividends capitalised at the appropriate cost of equity of the firm. Moreso, the market price of year 3 is added to the dividend in year 3 before discounting.
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