Consider four different stocks, all of which have a required return of 20 percen
ID: 2776814 • Letter: C
Question
Consider four different stocks, all of which have a required return of 20 percent and a most recent dividend of $4.40 per share. Stocks W, X, and Y are expected to maintain constant growth rates in dividends for the foreseeable future of 10 percent, 0 percent, and –5 percent per year, respectively. Stock Z is a growth stock that will increase its dividend by 20 percent for the next two years and then maintain a constant 11 percent growth rate thereafter. What is the dividend yield for each of these four stocks?What is the expected capital gains yield for each of these four stocks?
Explanation / Answer
Answer:
Stock Z :Calculations
Market price of the stock at the end of year 2 =expected Dividend of year 3/ (Required rate of return - Growth rate)
= 7.03/ (20%-11%) = $78.11
Present value now of the market value of stock at the end of year 2 = $78.11/(1.2)2 = $54.24
Current market price
= PV of dividend in year 1+ PV of dividend in year 2 + PV now of market value of stock at the end of year 2 =
= $4.4+4.4+54.24 = $63.04
Computation of market price at the end of year 1:
= PV at the end year 1 of dividend in year 2 + PV at the end year 1, of market value of stock at the end of year 2 =
= $4.4/1.2 + $78.11/1.2 = $68.76
Dividend yield = Current dividend/CMP = $4.4/63.04 = 6.98%
Capital gain yield = ($68.76 - $63.04)/63.04 = 9.07%
A B C D E =D / (A-B) C/E Stocks Required rate of return Growth rate Current dividend Expected Next year dividend Current market price Dividend Yield W 20% 10% 4.4 4.84 48.40 9.09% X 20% 0 4.4 4.4 22.00 20.00% Y 20% -5% 4.4 4.18 16.72 26.32%Related Questions
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