Your bank account pays an interest rate of 8 percent. You are considering buying a share of stock in XYZ Corporation for $110. After 1, 2, and 3 years, it will pay a dividend of $5. You expect to sell the stock after 3 years for $120. Is XYZ a good investment? Support your answer with calculations.

Explanation:

To decide if buying a share of stock in XYZ  Corporation for $110 is a good investment you must calculate the present value of the cash flow stream tha it generates, at the rate of 8% (compunded monthly), and compare with the purchase price of $110.

1. Present value of the three dividends:

Discount each dividend according to the year when it will be paid.

2. Present value of the $120 (selling price)

The stock will be sold in 3 years (36 months)

3. Total present value of the stock

Add the two present values found above:

4. Compare with the current $110 price of the stock in XYZ Corporation

Since the investement today $110 is greater than the present value of the cash flows that it will produce this is not a good investment.

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