Question

Ashworth Corp has just paid its annual dividend of $10.00. The company has announced an aggressive expansion plan. The plan requires investment for the next three years. The company decides to fund the three years of expansion by not paying a dividend for three years. The company will resume paying dividends in year 4 with a dividend of $12.00 per share. After this, the company will grow its dividends at a rate of 8.0% thereafter {D₁ = D₂ = D₃ = $-, D₄ = $12.00, D₅ = $12.00(1 + 8.0%), and so on…}. The company’s cost of equity is 12.0%.

1. The company’s capital gains yield today is (round to 1 decimal place)?

a. 0.0%

b. 4.0%

c. 8.0%

d. 12.0% <---Answer

e. 16.0%

Answer 1

Expected Dividend in Year 4, D4 = $12.00
Growth Rate, g = 8.0%
Cost of Equity, ke = 12.0%

Expected Price in 3 years, P3 = D4 / (ke - g)
Expected Price in 3 years, P3 = $12.00 / (0.12 - 0.08)
Expected Price in 3 years, P3 = $300.00

Current Price, P0 = P3 / (1 + ke)^3
Current Price, P0 = $300.00 / 1.12^3
Current Price, P0 = $213.534

Expected Price in 1 year, P1 = P3 / (1 + ke)^2
Expected Price in 1 year, P1 = $300.00 / 1.12^2
Expected Price in 1 year, P1 = $239.158

Capital Gain Yield = (P1 - P0) / P0
Capital Gain Yield = ($239.158 - $213.534) / $213.534
Capital Gain Yield = 0.12 or 12.0%