Question

You own 1,100 shares of stock in Avondale Corporation. You will receive a $2.60 per share dividend in one year. In two years, the company will pay a liquidating dividend of $75 per share. The required return on the company's stock is 20 percent.

b. If you would rather have equal dividends in each of the next two years, how many shares would you sell in one year? (Do not round intermediate calculations and round your answer to 2 decimal places

Answer 1

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Answer:

The price of the stock today is the PV of the dividends, so:

P0 = 2.6/1.2 + 75/1.2^2 = 54.25

To find the equal two year dividends with the same present value as the price of the stock,

54.25 = D/1.2 + D/1.2^2

D = $35.51

We now know the cash flow per share we want each of the next two years. We can find the price of stock in one year

P1 = 75/1.2 = 62.5

Since you own 1100 shares

Cash flow in year one = 1100*35.51 = 39061

But you'll only get:

Dividends received in one year = 1100*2.6 = 2860

So, in one year you'll have to sell shares to increase cash flow.

Shares to sell = (39061 - 2860)/62.5 = 579.22

Note: Please try with 579.20 if the above solution comes incorrect due to rounding