A stock with a constant dividend growth rate of 5% is expected to make a $2 divi
ID: 2773676 • Letter: A
Question
A stock with a constant dividend growth rate of 5% is expected to make a $2 dividend in one year. If you require a 12% return on your investment, which of the following statements is INCORRECT? Note: P0 = D1/(R–g) or R = (D1/P0) + g.
A. The current stock price is $28.57.
B. The dividend yield is 7%.
C. The capital gains yield is 12%.
D. The stock price will grow at an annual 5%.
A. The current stock price is $28.57.
B. The dividend yield is 7%.
C. The capital gains yield is 12%.
D. The stock price will grow at an annual 5%.
Explanation / Answer
Stock price = D1÷(r-g)
D1 is next expected dividend
r is cost of common stock
g is growth rate
Since, share dividend constant growth rate is 5%, share will also increase at constant 5%. if share price increase by constant 5%, capital gain yield will also be 5% only.
Hence, Incorrect option is C. The capital gains yield is 12%.
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