Question

XYZ has been growing at a rate of 30% per year in recent years. This same supernormal growth is expected to last for another two years (30% for Year 0 to Year 1 and Year 1 to Year 2), then at a constant rate of 10% thereafter.

b) Now assume that XYZ’s period of supernormal growth is to last another 5 years rather than 2 years. How would this affect its price, dividend yield and capital gains yield?

Please provide the answers in words.

Answer 1

According to Gordon growth model,

Price = D1/(Required Rate - Growth Rate)

Suppose growth rate is high, then the denominator will be low and hence the price of the share will rise as we will be dividing from less denominator than what were doing previously. Hence, the price will rise.

Dividend Yield = Most Recent Dividend/Price of Stock

If we assume dividend to be constant throughout, then rise in price will reduce the dividend yield and denominator will rise. Hence, dividend yield will fall.

Capital Yield = (Final Price - Initial Price)/Initial Price.

Since, final price will rise and Initial price will be constant(in year 1), the capital yield will rise as final price rises because of growth rate for next 5 year is rising to 30%.

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