An investor is considering investing in Tawari Company for one year. He expects to receive $2 in dividends over the year and feels he can sell the stock for $30 at the end of the year. What is the maximum he can pay now to earn at least a 14 percent return on his investment?
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A. B. C. D.A
HPR = [D + (End - Beginning]/Beginning
14 = [2 + (30 - P)]/P
1.14P = 32 so P = $28.07
To calculate the maximum price the investor can pay now to earn at least a 14 percent return on his investment, we need to determine the present value of the expected cash flows.
The cash flows in this case consist of the dividends received during the year and the expected selling price of the stock at the end of the year.
Step 1: Calculate the present value of dividends: The investor expects to receive $2 in dividends over the year. To find the present value of these dividends, we discount them back to the present using the required return of 14 percent.
PV(dividends) = Dividends / (1 + required return) = $2 / (1 + 0.14) = $2 / 1.14 ≈ $1.75
Step 2: Calculate the present value of the expected selling price: The investor expects to sell the stock for $30 at the end of the year. Similar to the dividends, we need to discount this expected future cash flow back to the present using the required return.
PV(selling price) = Selling price / (1 + required return) = $30 / (1 + 0.14) = $30 / 1.14 ≈ $26.32
Step 3: Calculate the maximum price the investor can pay now: The maximum price the investor can pay now is equal to the present value of the expected future cash flows.
Maximum price = PV(dividends) + PV(selling price) = $1.75 + $26.32 ≈ $28.07
Since the investor wants to earn at least a 14 percent return on his investment, he should not pay more than $28.07 for the stock.
Among the given answer choices, the closest option is A. $28. Therefore, the correct answer is A. $28.