Question

Conroy Consulting Corporation (CCC) has been growing at a rate of 30% per year in recent years. This same nonconstant growth rate is expected to last for another 2 years (g0,1=g1,2=30%).

a. If D0 = $2.50, rs =12%, and gL = 7%, then what is CCC’s stock worth today? What is its expected dividend yield for the first year? What is the expected capital gains yield for the first year?

b. Now assume that CCC’s period of nonconstant growth is to last another 5 years rather than 2 years (g0,1 = g1,2 = g2,3 = g3,4 = g4,5 = 30%). How would this affect its price, dividend yield, and capital gains yield? Answer in words only.

Answer 1

Answer a.

D0 = $2.50

D1 = $2.50 * 1.30
D1 = $3.25

D2 = $3.25 * 1.30
D2 = $4.225

D3 = $4.225 * 1.07
D3 = $4.52075

P2 = D3 / (rs - gL)
P2 = $4.52075 / (0.12 - 0.07)
P2 = $90.415

P0 = $3.25 / 1.12 + $4.225 / 1.12^2 + $90.415 / 1.12^2
P0 = $78.35

Dividend Yield = D1 / P0
Dividend Yield = $3.25 / $78.35
Dividend Yield = 0.0415 or 4.15%

Capital Gain Yield = Required Return - Dividend Yield
Capital Gain Yield = 12.00% - 4.15%
Capital Gain Yield = 7.85%

Answer b.

If nonconstant growth rate last for 5 years then dividend per shares during each year will increase which will lead to increase in price. Increase in price will lead to decrease in dividend yield and increase in capital gain yield.