Bensen Co. paid a dividend of $5.25 on its common stock yesterday. The company's dividends are expected to grow at a constant rate of 8.5% for the next two years. The stock is expected to sell for $35 at the end of year 2. The required rate of return on this stock is 15.5%. You observe a market price of $78.50 for the stock. Should you purchase this stock?

Question

Business

Sidney Shepherd

19 April, 03:17

Bensen Co. paid a dividend of $5.25 on its common stock yesterday. The company's dividends are expected to grow at a constant rate of 8.5% for the next two years. The stock is expected to sell for $35 at the end of year 2. The required rate of return on this stock is 15.5%. You observe a market price of $78.50 for the stock. Should you purchase this stock?

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Azul Larson · Answer 1

No, because you will lose money

Explanation:

The current stock price is $78.50

it will yield $5.70 and $6.18 in dividends in the next two years. In two years you can expect to sell the stock at $35, so the cash flows will be:

initial - $78.50

CF1 = $5.70

CF2 = $6.18 + $35 = $41.18

discount rate = 15.5%

NPV = - $78.50 + $5.70/1.155 + $41.18/1.155² = - $78.50 + $4.94 + $30.87 = - $42.69

Since the NPV is negative, it is a bad investment