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Blockbuster Inc. just paid a dividend of​ $2 per share. Dividends are expected to grow at a rate of minus​ 50% annually over the next three years. After​ that, it is expected that Blockbuster will cease paying dividends forever. What is the fair market price for a share of Blockbuster if shareholders require a return of​ 12%?
A) $2.21
B) $2.95
C) $1.61
D) $0
E) $1.47

Answer :

Answer:

E) $1.47

Explanation:

Hi, first we need to estimate the value of all future dividends, since last dividend was $2 and it´s going to grow at -50% every year, for 3 years and then stop paying dividends, the cash flows that we need to bring to present value are.

D(1)= $2*(1-0.5)=$1

D(2)=$1*(1-0.5)=$0.50

D(3)=$0.50*(1-0.5)=$0.25

And no dividends from then on.

Now, we need to bring them to present value in order to find the pair market price of this share, that is:

[tex]Price=\frac{1}{(1+0.12)^{1} } +\frac{0.50}{(1+0.12)^{2} } +\frac{0.25}{(1+0.12)^{3} }[/tex]

[tex]Price=0.893+0.399+0.178=1.47[/tex]

So, the price of this share is $1.47, that is E)

Best of luck

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