Question

10. Aunt Kathleen owns 3000 preferred shares of ABC Inc., and she is thinking of selling 100 of these shares to pay for a new computer. These shares pay a stable quarterly dividend of $0.65 per share (i.e., there will be four dividend payments in a year, and each payment is $0.65 per share). Aunt Kathleen’s required return is 12% APR compounded semi-annually.

1. What is the effective annual return (EAR) based on an APR of 12% compounded semi-annually?   (1 mark)
2. What is the effective return per dividend payment period for Aunt Kathleen? (1 mark)
3. What is the estimated stock price based on the Constant Dividend model?  
4. What is the maximum amount of money that Aunt Kathleen can spend on the new computer if she only uses the receipts from the sale of 100 shares of ABC’s preferred shares to pay for it?                    (1 mark)

Answer 1

a) Effective Annual Return = (1+ 0.12/2)2 - 1 = 12.36%

b) Effective return per dividend payment period ( i.e Quarterly) =

  (1+ X/4)4 -1 = 12.36%

1 + X/4 = (1.1236)1/4

1+ X/4 = 1.02956

X = 0.02956 *4

X = 11.824 annually or 2.956% Quartrely

c) Estimated Stock price = Dividend ( Constant Payments) / Discount Rate

= 0.65/ 2.956%

= $ 219.89   

d) Max. money she can spent on Computer = 100 Shares * Share Price ( $ 219.89) = $21,989

Happy Learning!