Question

Varigrowth Inc. just paid a dividend of ?$1.45 (i.e.,D0=?$1.45?).Such dividend is expected to grow by 45?% per year for the next 3? years, after which it is expected to grow at a? long-run rate of 2.5?%. Assuming investors require a 13?% return on the? stock,?

a) What is the price at? t=3? $---(to the nearest? cent)?

b) What is its price? today???$---(to the nearest? cent)?

c) What is your total rate of return? (% to two? decimals) if in one year the price is ?$22.92 and the dividend is ?$2.03?? --- %

What is your dividend? yield? --- %

What is your capital gain? (loss) yield? --- %

Answer 1

Answer a.

D0 = $1.45

D1 = $1.4500 * 1.45 = $2.1025
D2 = $2.1025 * 1.45 = $3.0486
D3 = $3.0486 * 1.45 = $4.4205

Constant grow rate, g = 2.5%
Required Return, r = 13%

D4 = $4.4205 * 1.025 = $4.5310

P3 = D4 / (r - g)
P3 = $4.5310 / (0.13 - 0.025)
P3 = $43.15

So, price at t=3 = $43.15

Answer b.

P0 = $2.1025/1.13 + $3.0486/1.13^2 + $4.4205/1.13^3 + $43.15/1.13^3
P0 = $37.22

So, price today is $37.22

Answer c.

P0 = $37.22
P1 = $22.92
D1 = $2.03

Rate of Return = (P1 + D1 - P0) / P0
Rate of Return = ($22.92 + $2.03 - $37.22) / $37.22
Rate of Return = -0.3297
Rate of Return = -32.97%

Dividend Yield = D1 / P0
Dividend Yield = $2.03 / $37.22
Dividend Yield = 0.0545
Dividend Yield = 5.45%

Capital Gain (loss) Yield = Rate of Return - Dividend Yield
Capital Gain (loss) Yield = -32.97% - 5.45%
Capital Gain (loss) Yield = -38.42%