Question

SCI just paid a dividend ( D0 ) of $3.12 per share, and its annual dividend is expected to grow at a constant rate (g) of 6.50% per year. If the required return ( rs ) on SCI’s stock is 16.25%, then the intrinsic value of SCI’s shares is per share. Which of the following statements is true about the constant growth model? The constant growth model can be used if a stock’s expected constant growth rate is less than its required return. The constant growth model can be used if a stock’s expected constant growth rate is more than its required return. Use the constant growth model to calculate the appropriate values to complete the following statements about Super Carpeting Inc.: • If SCI’s stock is in equilibrium, the current expected dividend yield on the stock will be per share. • SCI’s expected stock price one year from today will be per share. • If SCI’s stock is in equilibrium, the current expected capital gains yield on SCI’s stock will be .

Answer 1

Answer a.

Last Dividend, D0 = $3.12
Growth Rate, g = 6.50%
Required Return, rs = 16.25%

D1 = D0 * (1 + g)
D1 = $3.12 * 1.065
D1 = $3.3228

Intrinsic Value, P0 = D1 / (rs - g)
Intrinsic Value, P0 = $3.3228 / (0.1625 - 0.0650)
Intrinsic Value, P0 = $34.08

Answer b.

The constant growth model can be used if a stock’s expected constant growth rate is less than its required return.

Answer c.

Dividend Yield = D1 / P0
Dividend Yield = $3.3228 / $34.08
Dividend Yield = 0.0975 or 9.75%

Answer d.

Price in 1 year, P1 = P0 * (1 + g)
Price in 1 year, P1 = $34.08 * 1.065
Price in 1 year, P1 = $36.30

Answer e.

Capital Gain Yield = (P1 - P0) / P0
Capital Gain Yield = ($36.30 - $34.08) / $34.08
Capital Gain Yield = 0.0650 or 6.50%