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The ELL common stock pays an annual dividend of $1.90 a share and is committed to maintaining a...

Question:

The ELL common stock pays an annual dividend of $1.90 a share and is committed to maintaining a constant dividend.

How much are you willing to pay for one share of this stock, if your required return is 11 percent?

a. $15.56

b. $16.67

c. $17.27

d. $18.88

e. $20.00

Stock Return of a Constant Dividend Stock:

The return on a stock consists of its dividend yield and its capital gains yield. When the dividend is constant, however, as is the case of preferred shares, the company's stock price stays the same in perpetuity. Thus, there is no capital gains yield on such a stock, only a dividend yield.

Answer and Explanation:

Let:

  • D = dividend
  • r = required return.

The price is the value of the perpetuity of dividends:

{eq}Price = \frac{D}{r}\\ Price = \frac{1.9}{0.11}\\ Price = 17.27\%\\ {/eq}

The correct answer is c.


Learn more about this topic:

What is a Perpetuity? - Definition & Formula

from Finance 101: Principles of Finance

Chapter 6 / Lesson 4
5.3K

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