Category: Business and Money
Asked by: lola5-ga
List Price: $15.00
10 Apr 2005 18:54 PDT
Expires: 10 May 2005 18:54 PDT
Question ID: 507633
Andahl Corporation stock, of which you own 500 shares, will pay a $2 per share dividend one year from today. Two years fron now Andahl will close its doors; stockholders will recieve liquidating dividends of $17.5375 per share. The required rate of retun on Andahl stock is 15 percent. a. What is the current price of Andahl stock? b. You prefer to receive equal amounts of money in each of the next two years. How will you accomplish this?
Answered By: omnivorous-ga on 11 Apr 2005 13:07 PDT
Lola5 ? Would that Gene Andahl?s company? Wikipedia ?Gene Amdahl? http://en.wikipedia.org/wiki/Gene_Amdahl But all kidding aside, the value of a stock is the Present Value of expected future cash flows. If you use PV discount factors you can multiple them by cash flows: PV factor, end year 1 = 1/1.15 = 0.8696 PV factor, end year 2 = 1/(1.15*1.15) = 0.7561 So the present value of the dividends paid per share are: Year 1: $2.00 * 0.8696 = $1.74 Year 2 $17.5375 * 0.7561 = $13.26 So, the stock price today will be $15.00. The stock price will actually rise for the next 364 days as the PV of both payments increase. --- Your problem is that values change every day. And selling 250 shares today gives you $3,750 immediately ? plus $500 in dividends or $4,250. By keeping the other 250 shares you?ll net $4,384 in year 2. You could borrow against year 2 with a margin loan ? or sell a few more shares. It turns out that you?ll equalize cash flows at 254 shares: Sell 254 = $3,810 sales + $492 dividends = $4,302 Keep 246 = $17.5375 * 246 = $4,314 It?s as close as you can come in full-share transactions. But you can take your $4,302 and invest it in a 1-year Treasury bill and more than make up the difference! Best regards, Omnivorous-GA
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From: dclmwop-ga on 01 May 2005 13:11 PDT
I'm sorry but I disagree with the second part of the answer -- because it seems to be answering the wrong question. The original question asks how we can get equal cashflows "in each of the next two years." Omnivorous's answer compares cashflow right now (in Year 0, if we sell stocks in Year 0) with cashflow in Year 2. If you sell 254 shares now, at $15/share, you are getting that cashflow now, not in Year 1. In Year 1, you will get your dividends of $492 ($2/share * the remaining 246 shares). That's not what the original question wants. Instead, I believe the answer lies in selling shares in Year 1 after dividends are paid on the entire 500 shares, at $15.25/share. The closet number I got was selling 237 shares in Year 1 (letting the other shares be liquated at the end of Year 2).
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