Tattletale News Corp. has been growing at a rate of 10% per year, and you expect

Question

Tattletale News Corp. has been growing at a rate of 10% per year, and you expect this growth rate in earnings and dividends to continue for another 3 years. The last dividend paid was $3. The discount rate is 19% and the steady growth rate after 3 years is 4%. o. What is the capital gain in stock price from year O to year 1? (Do not round intermediate caiculations. Enter your answer as a dollar amount rounded to 3 decimal places.) b. Calculate the expected rate of return. (Do not ound intermediate celculations. Round your answer to the nearest whole percent.) ed rate of

Explanation / Answer

(a) Three Year Growth Rate = 10 % per annum

Last Dividend = D0 = $ 3

Therefore, D1 = 3 x 1.1 = $ 3.3, D2 = 3.3 x 1.1 = $ 3.63 and D3 = 3.63 x 1.1 = $ 3.993

D4 = 3.993 x 1.04 = $ 4.15272

Discount Rate = 19 %

Terminal Value of Dividends at the end of Year 3 = 4.15272 / (0.19 - 0.04) = $ 27.6848

Stock Price at the end of Year 0 = 3.3 / 1.19 + 3.63 / (1.19)^(2) + 3.993 / (1.19)^(3) + 27.6848 / (1.19)^(3) = $ 24.1346

Stock Price at the end of year 1 = 3.63 / 1.19 + 3.993 / (1.19)^(2) + 27.6848 / (1.19)^(2) = $ 25.4202

Capital Gains between year 1 and year 2 = (25.4202 - 24.1346) = $ 1.2856 or $ 1.286 approximately.

(b) Expected Rate of Return from Year 0 to Year 1 = K = (D1 / P0) + Prevailing growth rate = (3.3/24.1346) + 0.1 = 0.2367 or 24 % approximately.

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