You are given the following information about three stocks: -Rust Petroleum is e

Question

You are given the following information about three stocks: -Rust Petroleum is expected to pay a $1.20 dividend at the end of the year. The required return on Rust Petroleum's stock is 11% and its dividend is expected to grow at a constant rate of 7% per year. -Schubert Fabric is expected to pay a $1.50 dividend at the end of the year. Schubert Fabric's dividend yield and capital gains yield both equal 696. Chapman Tech's current stock price is $15 per share, its required return is 13%, and its dividend yield is 8%. Use the constant growth valuation formula to evaluate each stock's next expected dividend, current price, required return, expected dividend growth rate, and dividend yield. Assume the market is in equilibrium. In the table below, indicate which stock has the highest value for each of these metrics. Which stock has the highestRust Petroleum Schubert Fabric Chapman Tech Expected dividend (D1) Current stock price (Po) Required return (rs) Expected dividend growth rate Dividend yield (DY) Capital gains yield

Explanation / Answer

A.

- Rust Petroleum

Expected Dividend = $1.20
Required Return = 11%
Growth Rate = 7%
Current Stock Price = 1.20 / (0.11 - 0.07) = $30
Dividend Yield = 1.20 / 30 = 4%
Capital Gain Yield = 11 - 4 = 7%

- Schubert Fabric

Expected Dividend = $1.50
Capital Gain Yield = 6%
Dividend Yield = 6%
Required return = 12%
Current Stock Price = 1.50 / 6% = $25
Growth Rate = 12 - 6 = 6%

- Chapman Tech

Current Stock Price = $15
Required Return = 13%
Dividend Yield = 8%
Capital Gain Yield = 13 - 8 = 5%
Growth Rate = 13 - 8 = 5%
Expected Dividend = 15 x 8% = $1.20

B.

1. Ke = Rf + (Rm - Rf) x Beta = 6 + 5 x 0.7 = 9.5%
Stock Price = (1.80 x 0.96) / (0.095 + 0.04) = $12.80 ...Thus, Option B.

2. Expected Dividend Yield = (1.80 x 0.96) / 12.80 = 13.5% ...Thus, Option B.

3. Expected stock price in one year = (1.80 x 0.96 x 0.96) / (0.095 + 0.04) = $12.29 ...Thus, Option A.

4. No, rational investor will never invest in Swinton Mining since he would have to suffer loses year by year.

Stock that has Highest Rust Petroleum Schubert Fabric Chapman Tech Expected Dividend Current Stock Price Required Return Growth Rate Dividend Yield Capital Gain Yield

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