Question

Suppose ABN Amro will pay a dividend of €1.70 per share in two years, and a dividend of €2.00 per share in three years. You expect ABN Amro’s stock price to be €20 in three years. If ABN Amro’s equity cost of capital 8%:

a. What price would you be willing to be pay for a share today if you planned to hold the stock for three years?

b. Suppose instead you plan to hold the stock for two years. What price would you expect to be able to sell a share of ABN Amro stock for in two years (after receiving the dividend of €1.70)?

c. Given your answer in (b), what price would you be willing to pay for a share of ABN Amro stock today, if you plan to hold the stock for two years? How does this compare to your answer in (a)?

Answer 1

PV = CF1/(1+r) + CF2/(1+r)² + CF2/(1+r)³ + CF3/(1+r)⁴ ….. CFt/(1+r)^t

Where, CFt is cash flow at time=t

r is discount rate

Dividend in 2 years = € 1.70

Dividend in 3 years = € 2

Stock price in 3 years = € 20

Cost of capital = 8%

a.

You plan to hold the stock for 3 years

Price of stock today , P = 1.70/(1+8%)² + (2+20)/(1+8%)³

P = € 18.92

b.

You plan to hold the stock for 2 years

Price of stock in 2 years , P₂ = (2+20)/(1+8%)

P = € 20.37

c.

You plan to hold the stock for 2 years

Price of stock today , P = (1.70+20.37)/(1+8%)²

P = € 18.92

Price is same as calculated in (a), because the stock is selling for its fair (market) value in both cases.