Question

Varigrowth Inc. just paid a dividend of ?$1.38 ?(i.e., D0? = ?$1.38?). Such dividend is expected to grow by 45?% per year for the next 3? years, after which it is expected to grow at a? long-run rate of 4.5?%. Assuming investors require a 12?% return on the? stock, ?a) What is the price at? t=3? ?$*** ?(to the nearest? cent) ?b) What is its price? today???? $***(to the nearest? cent) ?c) What is your total rate of return? (% to two? decimals) if in one year the price is ?$45.71 and the dividend is ?$2.12?? *** % What is your dividend? yield? ***?%?? What is your capital gain? (loss) yield?***% *** answers

Answer 1

a) Computation of market price at the end of year 3 using Gordon Growth Mdel

P3 = D4 / (Ke-g)

where,

P3 - Market price at the end of year 3

D4 - Expected dividend in year 4

Ke - rate of return

g - growth rate

P3 = D4 / (Ke-g)

= (1.38*1.45*1.45*1.45*1.045) / (.12 - .045)

= 4.3964 / .075

= $58.62

b) Computing current share price by discounting the cashflow at required return

Year	Dividend	PVF@12%*	Present Value (Cashflow*PVF)
1	2.001	0.893	1.79
2	2.9015	0.797	2.31
3	62.8271(4.2071+58.62)	0.712	44.73

current share price = $48.83 (1.79+2.31+44.73)

*PVF = 1 / (1+r)ⁿ

c) Computation of total rate of return

(Price in year 1 - Price in year 0 + Dividend in year 1) /  Price in year 0

(45.71-48.83+2.12) / 48.83

-2.05%

d) Dividend Yield

Dividend in year 1) /  Price in year 0

2.12 / 48.83

4.34%

e) Capital loss Yield

(Price in year 1 - Price in year 0) /  Price in year 0

(45.71-48.83) / 48.83

-6.39%