Question

Use the information for the​ question(s) below.

Von Bora Corporation is expected to pay a dividend of​ $1.40 per share at the end of this year and a​ $1.50 per share at the end of the second year. You expect Von​ Bora's stock price to be​ $25.00 at the end of two years. Von​ Bora's equity cost of capital is​ 10%.

Suppose you plan to hold Von Bora stock for only one year. Your capital gain rate from holding Von Bora stock for the first year is closest​ to:

Answer 1

The capital gain rate is computed as shown below:

Price at the end of 1 year is computed as follows:

= (Dividend at the end of second year + Price at the end of two years) / (1 + cost of capital)

= ($ 1.50 + $ 25.00) / 1.10

= $ 24.09090909

Current share price is computed as shown below:

= Dividend at the end of one year / (1 + cost of capital) + (Dividend at the end of second year + Price at the end of two years) / (1 + cost of capital)²

= $ 1.40 / 1.10 + ($ 1.50 + $ 25.00) / 1.10²

= $ 23.17355372

So, the capital gain is computed as follows:

= $ 24.09090909 - $ 23.17355372

= $ 0.917355371

So, the capital gain rate will be as follows:

= $ 0.917355371/ $ 23.17355372

= 3.96% Approximately

Feel free to ask in case of any query relating to this question