A stock is expected to pay a year-end dividend of $2.00, i.e., D 1 = $2.00. The
ID: 2708943 • Letter: A
Question
A 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?
The company’s expected capital gains yield is 5%.
The company’s current stock price is $20.
The company’s dividend yield 5 years from now is expected to be 10%.
The constant growth model cannot be used because the growth rate is negative.
The company’s expected stock price at the beginning of next year is $9.50.
a.The company’s expected capital gains yield is 5%.
b.The company’s current stock price is $20.
c.The company’s dividend yield 5 years from now is expected to be 10%.
d.The constant growth model cannot be used because the growth rate is negative.
e.The company’s expected stock price at the beginning of next year is $9.50.
Explanation / Answer
We have:
Do= 2
G= -5%
Ke= 15%
We have following formula for stock price:
P= Do(1+g)/(Ke-g)
= 2x(1-0.05)/(0.15+0.05)
= 1.90/0.20
= 9.50
Hence option E is correct.
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