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17 June, 19:56

Railway Cabooses just paid its annual dividend of $3.10 per share. The company has been reducing the dividends by 10.9 percent each year. How much are you willing to pay today to purchase stock in this company if your required rate of return is 13 percent?

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  1. 17 June, 20:19
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    Answer: Po = Do (1+g) / Ke-g

    Po = $3.10 (1-0.109) / 0.13 - (-0.109)

    Po = $3.10 (0.891) / 0.13+0.109

    Po = $3.10 (0.891) / 0.239

    Po = $11.56

    Explanation: The current market price of the stock equals the current dividend paid multiplied by 1+g divided by the excess of cost of equity over growth rate. The growth rate is negative in this case, thus, the growth rate would be deducted from 1. Moreso, the growth rate will be added to cost of equity since it is negative. Thus, the amount that the investor will be willing to pay is $11.56.
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