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- Topic: A confusing question?

Author | Topic: A confusing question? |
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welkabbadj@2014-05-01 07:33:17 |
A review question asks: "An analyst estimates that a stock will pay a $2 dividend next year and that it will sell for $40 at year-end. If the required rate of return is 15%, what is the value of the stock?" I thought this meant that next year a 2 dollar dividend is paid, and at the end of this year it is sold for $40. That’s not the case. What am I missing in the grammatical structure of this sentence so I don\'t run into this problem on the exam? |

ron1707@2014-05-09 12:44:00 |
I don't care for this question because I would not place any weight on an analyst's target price but here is how I would answer the question, assuming I believed the analyst. Total cash flow next year if you buy the stock should be $42 ($40 stock price plus $2 in dividends). The discount factor for 1 year at 15% is 0.8696 which was calculated as 1/(1+.15), Multiplying the discount factor and the $42 of cash results in a net present value of $36.52. This assumes the analyst’s estimate of $40 is ex-dividend. |