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Deluxe Company expects to pay a dividend of $2 per share at the end of year 1, $3 per share at the end of year 2, and then be sold for $32 per share at the end of year 2. If the required rate of return on the stock is 15 percent, what is the current market value of the stock?

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TomShelby

Answer:

The current price of the stock is $28.20

Explanation:

The stock rate of return is 15% this includes both, the dividends and capital gains. Therefore, we should discount our expected cash flow at the required return rate:

Year 1:

2 / (1 + 0.15) = 2 / 1.15 = 1.73913

Year 2:

(3 dividends + 32 stock) / 1.15^2 = 35/ 1.3225 = 26.4650

Then we add both discounted cash flow:

1.73913 + 26.4650 = 28.20413

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