Question

You own 1,650 shares of stock in Avondale Corporation. You will receive a dividend of $1.50 per share in one year. In two years, Avondale will pay a liquidating dividend of $54 per share. The required return on Avondale stock is 20 percent.

  

1. Ignoring taxes, what is the current share price of your stock?

  

  

2. If you would rather have equal dividends in each of the next two years, how many shares would you sell in one year?

  

3. What would your cash flow be for each year for the next two years if you create equal homemade dividends? Hint: Dividends will be in the form of an annuity.

Answer 1

Part (a)

Price per share = D1 / (1 + Ke) + D2 / (1 + Ke)² = 1.50 / (1 + 20%) + 54 / (1 + 20%)² = $ 38.75

Part (b)

Let N be the number of shares sold.

Price at the end of year 1 = 54 / (1 + 20%) = 45

Hence, dividend proceed from all the shares at the end of year 1 + proceeds from sale of N shares = Dividends received from the balance shares at the end of year 2

Hence, 1,650 x 1.50 + N x 45 = (1,650 - N) x 54

Hence, N = 875

Hence, you would sell N = 875 shares

Part (c)

cash flow be for each year for the next two years if you create equal homemade dividends = Dividend each year = Liquidating dividend in year 2 = (1,650 - 875) x 54 = $ 41,850