Question

Company A just paid a dividend of $1.8 and expects to reduce its dividend at a constant rate of 5%. If the required rate of return is 20%, what will be the intrinsic value of the stock? What will be the dividend yield and capital growth rate of the stock next year?

Please show all the work.

Answer 1

Last Dividend, D0 = $1.8
Growth rate, g = -5%
Required Return, r = 20%

Expected Dividend, D1 = D0 * (1+g)
Expected Dividend, D1 = $1.8 * (1-0.05)
Expected Dividend, D1 = $1.71

Intrinsic Value, P0 = D1 / [r - g]
Intrinsic Value, P0 = $1.71 / [0.20 - (-0.05)]
Intrinsic Value, P0 = $1.71 / 0.25
Intrinsic Value, P0 = $6.84

Dividend Yield = D1 / P0
Dividend Yield = $1.71 / $6.84
Dividend Yield = 0.25 or 25%

Capital Growth Rate = Required Return - Dividend Yield
Capital Growth Rate = 20% - 25%
Capital Growth Rate = -5%