Question

. Blue Devil Corporation stock, of which you own 500 shares, will pay a $2 per share dividend one year from today. Two years from now Blue Devil will close its doors and stockholders will receive a liquidating dividend of $17.5375 per share. The required rate of return on Blue Devil stock is 15 percent.

(a) What is the current price of Blue Devil stock?

(b) You prefer to receive equal amounts of money in each of the next two years. How can you accomplish this?

please provide solution in neat manner!

For (b), answer is " Need to sell 236.94 shares at the end of year 1 to generate $3,613.37 of additional first year income." but I don't know how it got this solution! Please explain!

Thumsup will be pushed

Answer 1

(a) Current Price of stock is equal to the present value of future dividends

= 2/1.15 + 17.5375/(1.15)²

= $15

(b)Price of stock one year from today = 17.5375/1.15 = $15.25

Let the number of shares sold at the end of year 1 = x

Now, equal amount of money will be received at the end of each of the 2 years

Hence, 2*500 + 15.25*x = 17.5375*(500-x)

1,000 + 15.25x = 8,768.75 – 17.5375x

X = 236.94

Hence, sell 236.94 share and received 236.94*15.25 = $3,613.37 plus dividend 2*500 = 1,000 at the end of year 1 and receive same amount at the end of year 2