Question

Astro Burger announced today that it will begin paying annual dividends. The first dividend of $0.31 will be paid in one year. The second and third annual dividends will be $0.36 and $0.51, respectively. The forth annual dividend will be $0.81, and subsequent dividends will increase at 2.5 percent per year in perpetuity. If your required return is 10 percent annually, how much are you willing to pay today to buy this stock?

A) $2.27

B) $11.07

C) $9.08

D) $11.38

E) $11.35

Answer 1

The dividend paid in 1st year is = $0.31

The dividend in 2nd year is $0.36

The dividend for the 3rd year is $0.51

The dividend for the 4th year is $0.81

The growth of dividend in perpetuity

P4= D5/ re - G

=0.81*1.025/0.075

=$11.07

The price paid for the stock today is:

0.31/1.1 +0.36/1.1^2+ 0.51/1.1^3 + 0.81/1.1^4+ 11.07/1.1^4

=0.2818 +0.2975 + 0.3832 + 0.5532 + 7.561

=$9.08

So, the price that we should pay for the stock today is $9.08

The correct option is option C.