(a) Arbitrage Financial is offering an investment with the following cash flows:
|
Year
|
1
|
2
|
3
|
4
|
|
Cash flow
|
$200
|
$400
|
- $100
|
$500
|
(note that the cash flows in Years 1, 2, and 4 are positive, and the cash flow in Year 3 is negative.)
You observe the following prices of pure discount (i.e., zero-coupon) bonds, which pay a single cash flow of $100 at maturity:
|
Price, $
|
Maturity, years
|
|
95.24
|
1
|
|
89.85
|
2
|
|
83.96
|
3
|
|
77.73
|
4
|
What is a fair price (to the nearest dollar) for the investment from Arbitrage Financial?
(b) Arbitrage Financial offers another product called a “mystery growth” stock. This investment pays a dividend of $5 per share each year for the next five years, beginning one year from now. After Year 5, the dividend will grow at a constant rate. The price of the stock is $57.55 per share, and shares of similar risk currently have a required return of 12%. What long-term growth rate in dividends is needed to justify the current share price? Express your answer in decimal form, to three decimal places, e.g., if you think the answer is 2.7%, write it as 0.027.