Question

A stock paying $5 in annual dividends sells now for $95 and has an expected return of 11%. What would be the stock price one year from now?

* I know the answer is 100.45. But I don't understand why can't i treat it like simple problem and do the following.

Div(PMT)=5, Po(PV)=95, I/yr=11%, N=1, P1(FV)? which in the calculator would give me 110.450.

I can see other answers on chegg. Please kindly answer to my specific question, not showing the other way.

Answer 1

HI

The formula you are showing is useful for bond formula calculation where coupon value is in additional to the final value of par value of bond.

but in stock, when a dividend is paid then it is expected than stock price will decrease by the same amount. hence this formula cannot be used here.

We will simply have tp find out next year stock value using 11% return and subtract annual dividend to find out stock price next year.

Next year stock price = 95*(1+11%) - 5

=105.45 -5

=$100.45

Thanks