Question

If a stock pays a constant annual dividend then the stock can be valued using the

Answer 1

If a stock pays a ‘constant annual dividend’ then the stock can be valued using the ‘perpetuity present value formula.’

Explanation:

• Perpetuity security is an infinite sequence of cash flows that take place at the ‘end of each time period’. ‘Perpetuity’ is a constant flow of cash that has no end. There is an equal time period between the levels of the cash flow.  

• The ‘present value’ of the perpetuity can be calculated where it equals the ‘periodic cash flow’ divided by the ‘interest rate’.  

This can be shown in the following formula:

$\bold{\mathrm{PMT}=\mathrm{PV} \times \mathrm{i}}$

PMT is the ‘annual scholarship withdrawals’

i is the ‘periodic interest rate’

PV is the endowment value.