Frank Castanza owns 100 shares in a weapons company called Guns-R-Us.

Frank Castanza owns 100 shares in a weapons company called Guns-R-Us. Frank brags about its steady, annual dividend of $1.25 per share. You are jealous of the dividend but philosophically opposed to weapons companies, so you can’t buy the stock.

Instead, you have identified the Paper Street Soap Factory (PSSF) which is developing a new biodegradable bath soap. The company plans to begin paying an annual dividend of $1.25 starting in two years. Stockholders in both companies require a return of 7.5%. A stock price and dividend forecast for the two companies is provided in the table. (Assume that dividends are paid in perpetuity.) Your plan is to buy shares in PSSF today, sell some at Year 1 and hold the remainder in perpetuity. How many shares do you have to buy today in order to earn the same annual income as Frank?

Guns-R-Us PSSF
Year Price Dividend Price Dividend
0 16.66667 15.50388
1 16.66667 1.25 16.66667 0
2 16.66667 1.25 16.66667 1.25
3 16.66667 1.25 16.66667 1.25

A) 93
B) 100
C) 107.5
D) 116.67
E) 125

ANSWER

C