You own 1100 shares of stock in Avondale Corporation You wil

You own 1,100 shares of stock in Avondale Corporation. You will receive a $2.60 per share dividend in one year. In two years, Avondale will pay a liquidating dividend of $75 per share. The required return on Avondale stock is 20 percent. Ignoring taxes, what is the current share price of your stock? (Do not round intermediate calculations. Round your answer to 2 decimal places. (e.g., 32.16)) 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. Round your answer to 2 decimal places. (e.g., 32.16)) What would your cash flow be for each year for the next two years? Hint: Dividends will be in the form of an annuity.

Solution

Solution :

Ignoring taxes, what is the current share price of your stock ?

Price = sum of the discounted cash flows

P₀ = 2.60 / 1.20 + 75 / (1.20)^2 = $54.25

If you would rather have equal dividends in each of the next two years,

how many shares would you sell in one year?

Price in one year = 75/1.20 = 62.5

1100 * $2.60 = 2,860 dividends year 1

let x = the # of shares you keep

2860 + 62.5(1100 - x) = 75x

2860 + 68750 - 62.5x = 75x

71,610- 62.5x = 75x

71,610 = 137.5x

x = 520.8

so you sell: 1100 - 520.8 = 579.2 shares @$62.5 per share $36,200

Year 1: dividends 2860 + sale proceeds 36200 = $39,060

Year 2: liquidating dividend * #shares held: $75 * 520.8 = $39,060