Question

The next dividend payment by Blue Cheese, Inc., will be $1.89 per share. The dividends are anticipated to maintain a growth rate of 5 percent forever. The stock currently sells for $38 per share. What is the expected capital gains yield? Sample answer format: 2 decimals (unless integer) with NO %. 1.23% will be presented as 1.23 and 2.00% (integer) presented as 2.

Answer 1

Accoridng to the constant dividend growth model,

Share Price = Dividend For next period / ( Required return - Growth rate)

Let Required return = Ke

38 = 1.89 / ( Ke - 5%)

By Using cross multiplication,

38 * ( Ke - 5%) = 1.89

( Ke - 5%) = 1.89 / 38

( Ke - 5%) = 0.0497368

Ke - 0.05 = 0.0497368

Ke = 0.0497368 + 0.05

Ke = 0.0997368 or 9.97368%

So, The Required return is 9.97368%

Share Price for the beginning of next year = Dividend for next period / ( Required return - Growth rate)

= 1.89 * ( 1 + 5%) / ( 9.97368% - 5%)

= 1.9845 / 4.97368%

= 39.90003377

Capital Gains Yield = ( Share Price for next period - Current share price) / Current share price

= (39.90003377 - 38) / 38

Capital Gains Yield = 5.00%