Regarding KLX’s common stock, George indicated that it pays dividends annually a

Question

Regarding KLX’s common stock, George indicated that it pays dividends annually and analysts expect dividends to grow 5% annually over the next four years; after that analysts expect KLX’s annual dividend payout ratio to be 60% and its annual return on equity to be 5% forever. The last annual dividend KLX paid on December 31, 2017 was $1.02 per share. Further, George estimates the appropriate required rate of return on KLX’s stock is 10%. Given the above information, George asked you to use the non-constant growth dividend model to calculate:

The value per share of KLX’s stock on January 1 of years 2018, 2019, 2020, 2021, 2022 & 2023

The dividend yield, capital gains (losses) yield, and required return on KLX’s stock for each year between 2018 and 2022.

Explanation / Answer

KLX's Common stock First we will calculate the dividend for years 2019-2021 during which dividend will grow by 5% every year. D1= D0(1+g%) 2017 2018 2019 2020 2021 2022 2023 2024 and till forever Dividend 1.02 1.07 1.12 1.18 1.24 1.26 1.29 2% growth For 2022 and 2023: we will use the following formula: Growth = retention ratio*rate of return on equity Retention ratio = (1-payout ratio) i.e., 40.0% Rate of return on Equity = 5% Growth = 2.00% So for the first four years dividend will grow by 5% and the next two years by 2% Required rate of return: 10% 1.1 Non - constant growth model: Under this model the dividend rate experiences a non constant growth rate. To find the value of share at any point of time one needs to calculate the pv of the future returns from that point of time using the required rate of return as discounting rate 2017 2018 2019 2020 2021 2022 2023 2024 and till forever Dividend 1.02 1.07 1.12 1.18 1.24 1.26 1.29 2% growth At the end of year 1 2 3 4 5 6 Present value interest factor 0.91 0.83 0.75 0.68 0.62 0.56 (1/(1+discount rate)) We will discount the return of 2% which will go on for the rest of future with - (discount rate - growth rate) So for that period the value of share can be computed using this formula : D1/(discount rate-growth rate)*PVIF at current point Value of share on January 1st 14.05 14.43 14.81 15.16 15.50 14.37 14.66 Dividend yield 7% 7% 8% 8% 8% 9% 9% Capital gain yield 3% 3% 2% 2% -7% 2% Required rate 12.79 12.97 13.18 13.16 10.98 10.98 Notes to understand the calculation: The value of share has been calculated by calculating the present value of future dividend returns considering the formula mentioned above for 2022 - infinity growth rate and summing all of them So at any point of time the discount rate will start with 0.91. For example: for year 2020 the dividend will be discounted at 1st year discount factor and then 2021 at 2nd year discount factor and so on Required rate of return can be calculated using: D0*(1+g)/Share price + g%

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