You own 2,200 shares of stock in Avondale Corporation. You will receive a $1.40

Question

You own 2,200 shares of stock in Avondale Corporation. You will receive a $1.40 per share dividend in one year. In two years, the company will pay a liquidating dividend of $48 per share. The required return on the company's stock is 20 percent. a. Ignoring taxes, what is the current share price of your stock? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) 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, e.g., 32.16.) c. What would your cash flow be for each year for the next two years? Hint: Dividends will be in the form of an annuity. (Do not round intermediate calculations.)

Explanation / Answer

Solution-

Computation of current share price

Part a.
Share price = D1/(1+r)^1 + D2/(1+r)^2
= 1.40/(1.2)+48/(1.2)^2
= 1.17+33.33 = 34.50

Part b.

Computation of no. Of shares sell in one year -
Price in 1 year = 48/1.2 = 40
Dividend in year 1 = number of shares*dividend per share = 2200*1.40= $3080
Let number of shares kept be "x". Thus 3080+40*(2200-x) = 48x
3080+88000-40x= 48x or 91080=88x

X= 91080/88= 1035 shares
Thus number of shares sold = 2200 - 1035= 1165

Part C.

Computation of cash flows in year 1 and year 2
year 1 cash flow =year 1 dividend + sale proceeds

year 1 cash flow = 2200*1.40+1165*40 = $49680

Year 2 cash flow = liquidating dividend*no. of shares held
Year 2 cash flow = 48*1035= $49680.

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