stock is expected to pay a year-end dividend of $2.00, i.e., D1 = $2.00. The div

Question

stock is expected to pay a year-end dividend of $2.00, i.e., D1 = $2.00. The dividend is expected to decline at a rate of 5% a year forever (g = -5%). If the company is in equilibrium and its expected and required rate of return is 15%, which of the following statements is CORRECT?
a. The company's expected capital gains yield is 5%.

b. The constant growth model cannot be used because the growth rate is negative.

c. The company's dividend yield 5 years from now is expected to be 10%.

d. The company's current stock price is $20.

e. The company's expected stock price at the beginning of next year is $9.50.

Explanation / Answer

e. The company's expected stock price at the beginning of next year is $9.50.

soln:

Po= D1/(r-g)

2/(.15-(-0.05))

= $10

D2 = D1*(1+g) = 2*(1-0.05) = $1.9

P1 = D2/(r-g)

= 1.9/(.15+.05)

= $ 9.5

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