Question

Which year's stock price can be considered as the PV sum equivalence of the dividends: D₅, D₆, ....D_N, and beyond

(1) P4, the price at the end of year 4

(2) P5, the price at the end of year 5

(3) P6 , the price at the end of year 6

(4) PN, the price at the end of year N

• P4
• P5
• P6
• PN

Answer 1

The price of the stock as on today is computed as shown below:

= Dividend in year 1 / (1 + required rate of return)¹ +  Dividend in year 2 / (1 + required rate of return)² +   Dividend in year 3 / (1 + required rate of return)³ ............................. +   Dividend in year n / (1 + required rate of return)ⁿ

As can be seen in the above equation, if we want to compute the stock price as on today we shall start with the dividend to be received from next year or D1.

Applying the similar theory in the given problem, if we discount the dividend that we will be receiving from year 5 and afterwards , it will give the value of the stock at year 4 or P4.

So, the correct answer is option 1 i.e. P4, the price at the end of year 4.

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