3. a stock is expected to pay a year and dividend of two dollars. The dividend i

Question

3. a stock is expected to pay a year and dividend of two dollars. The dividend is expected to decline at a rate of 5% a year for ever. If the company expected and required rate of return is 15%, which of the following statements is true?
• The company's current stock price is $20
• the company stock price next year is expected to be $9.50
• the company's expected capital gains yield is 5%

4. Carter's preferred stock pays a dividend of one dollar per quarter. If the price of the stock is $50 per share what is the nominal annual rate of return?
• 8%
• 7.61%
• 7.23%

Explanation / Answer

According to the given information, D0 = $2.00 D1 = $2.00 (1 + (-0.05))      = $2.00 (1-0.05)      = $2.00 (0.95)      = $1.90 Grwoth rate = -5% Required rate of return = 15% From Dividend growth model,                                        P0 = (D1 / Ke -g)                                             = ($1.90 / 0.15 + 0.05)                                             = $1.90 / 0.2                                             = $9.5 The company's stock price is expected to be $9.5 for the next year 2) The nominal rate of return is calculated as                                Nominal rate of return = Annual Dividend / Price of the share Annual Dividend = $1.00 * 4 {Since 1year = 4 quarters}                           = $4.00                              Nominal rate of return = $4.00 / $50                                                                = 0.08 or 8% The correct option is a) 8.0%

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