Unit 2 Instant Feedback Task I. Example: AlphaDog Corp Ltd. is a company with a remarkably stable dividend paying policy. It also chooses not to reinvest any of its earnings and all profits are paid out as dividends to its investors. You have found from past records that the yearly dividend per share was $100 and there is no expectation of increase in the profits or in the dividends. You are considering buying 1000 shares and holding them for a period of 3 years, with an expected value at the end of $885 per share. The discount rate is given by the required rate of return, which is equal to 11.3%. What is the maximum amount you should be willing to pay? Because: Where: D. Pn PV = + (1+r)* ' (1+r)^ PV present value of the investment Dt = dividend paid out in time t Pn - Price of the stock in the final period n (the price when the stock is sold after a holding period) You calculate the present value of one share as: 100 100 100 885 PV = + + (1+0.113) (1+0.113) + (1+0.113) * (1+0.113) ' + 884.99 The present value of one share is $884.99. 1000 shares would then be worth $884,990. In this example of a stable dividend and interest rates, it is hardly surprising that the present value is almost perfectly equal to the price upon selling (the 1 cent difference is caused only by rounding up the selling price). Questions: NeverEverChanging Ltd. is a company with a remarkably stable dividend paying policy. It also chooses not to reinvest any of its earnings, and all profits are paid out as dividends to its investors. Yearly dividend per share in the past was $50 and there is no expectation of increase in the profits or in the dividends. You are considering buying 2000 shares and holding them for a period of 3 years, with an expected value at the end of $500 per share. The discount rate is given by the required rate of return, which is equal to 10.0%. 1) What is the maximum amount you should be willing to pay? 2) What would be the maximum amount you should be willing to pay, if the required rate of return was 5%?