Question

You expect a share of stock to pay dividends of $1.40, $1.65, and $1.90 in each of the next 3 years. You believe the stock will sell for $19.00 at the end of the third year.

a. What is the stock price if the discount rate for the stock is 20%?

b. What is the dividend yield for year 1?

c. What will be the dividend yield at the start of year 2?

Answer 1

Part A:

Stock Price = PV of Cash flows from it.

Year	CF	PVF @20%	Disc CF
1	$      1.40	0.8333	$      1.17
2	$      1.65	0.6944	$      1.15
3	$      1.90	0.5787	$      1.10
3	$   19.00	0.5787	$   11.00
Price of Stock			$   14.41

Part B:

DIv Yield = Div / Price

= $ 1.40 / $ 14.41

= 0.0972 i.e 9.72%

Part C:

P1 = PV of Future CFs

Year	CF	PVF @20%	Disc CF
2	$      1.65	0.8333	$      1.38
3	$      1.90	0.6944	$      1.32
3	$   19.00	0.6944	$   13.19
P1			$   15.89

Div Yield for Year 2 = D2 / P1

= 1.65 / 15.89

= 0.1038 i.e 10.38%