Questions: Lion Company is expected to pay a 3 dividend this year and a liquidating dividend of 20 per share next year. If your required return is 19%, what is the most you should pay for Lion Stock?

Solution Steps

To determine the most you should pay for Lion Stock, we need to calculate the present value of the expected dividends. The present value (PV) of future cash flows can be calculated using the formula:

\[ PV = \frac{D_1}{(1 + r)^1} + \frac{D_2}{(1 + r)^2} \]

where \( D_1 \) is the dividend this year, \( D_2 \) is the liquidating dividend next year, and \( r \) is the required return.

The expected cash flows from Lion Company are:

• \( D_1 = 3 \) (dividend this year)
• \( D_2 = 20 \) (liquidating dividend next year)

The required return is given as \( r = 0.19 \).

Using the present value formula for each cash flow, we have:

\[ PV = \frac{D_1}{(1 + r)^1} + \frac{D_2}{(1 + r)^2} \]

Substituting the values:

\[ PV = \frac{3}{(1 + 0.19)^1} + \frac{20}{(1 + 0.19)^2} \]

Calculating each term:

\[ PV = \frac{3}{1.19} + \frac{20}{1.4161} \]

Calculating the individual present values:

\[ PV \approx 2.5294 + 14.0959 \]

Thus,

\[ PV \approx 16.6253 \]

Rounding to four significant digits gives us \( PV \approx 16.64 \).

Final Answer