A company just paid out an annual dividend of $5. The dividend amount will grow at 3% annually forever.

A company just paid out an annual dividend of $5. The dividend amount will grow at 3% annually forever. If you buy a share today and sell it at year 5, how much of a capital gain (not including the dividend yield) would you expect? Assume that the required rate of return for this stock is 10%.

Group of answer choices

$13.49

$12.74

$11.72

$15.93

Expert Solution

Todays share price
Stock price = D1 / r - g

Where,
D1 = Expected Dividend =$5*1.03 =5.15
r= required rate of return
g= growth rate

=5.15/0.1-0.03

=73.57

Expected dividend at 6th year
=$5*1.03^6
=5.97026

Share price at year 5 = $5.97026/(0.10-0.03)
=$85.2894

Capital gain = $85.2894-73.57
=$11.72

jeff jeffy answered 3 years ago

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