The table below gives a firm’s EPS estimates and retention ratios for years 1 th

Question

The table below gives a firm’s EPS estimates and retention ratios for years 1 through 5. The growth in EPS from year 4 to year 5 and the retention ratio in year 5 will persist forever. The firm’s cost of equity is 15%.

time 0 1 2 3 4 5
retention rate 100% 100% 80% 25% 25%
EPS $2.00 $2.60 $3.38 $4.19 $4.51

What capital gains yield do investors expect from the end of year 2 to the end of year 3?

a. 11.13% b. 12.15% c. 13.17% d. 14.19%

What is the expected dividend (or current) yield for stock holders beyond year 5?

a. 12.50% b. 10.00% c. 7.50% d. 5.00%


Suppose instead of beginning to pay dividends in year 3, the firm announces its intent to wait until year 4 and then to pay dividends as scheduled in the table above. Other things constant, this change should
a. Increase the stock price.
b. Reduce the stock price.
c. Have no effect on the stock price.
d. No inference can be drawn about the effects on stock prices

Explanation / Answer

b c c

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