Question

The Billy Ice Cream Company pays a constant dividend. Last year, the dividend yield was 4.0 percent when the stock was selling for $16 a share.

a) What must the stock price be today if the market currently requires a 4.3 percent dividend yield on this stock?

b) If the total required return of this stock equals 8.9%, what should investors require as growth rate?

Answer 1

Answer;

Part a) Current Stock price = $14.88

Part b) Growth Rate = 4.31%

Explanation;

Part a)

Last year dividend Yield = 4%

Last year Stock Price = $16

Last Year Dividend =

Formula;Current Year Dividend(Last year)= Current year Stock Price(last year)  x current year Dividend Yield (Last Year) i.e. $16 x 4% = $0.64

Current Year stock Price = ?

Current Year Dividend Yield = 4.3%

Current Year Dividend = Last Year Dividend (Constant Dividend as per Que) i.e. $0.64

So,

Formula ; Current Year Price = Dividend / Dividend Yield %

= $0.64 / 4.3%

= $14.8837 or $14.88

Part b)

Current Year Price (Growth rate) = Dividend 0 + Growth rate /(Required Return - Growth rate )

Current Year Price = $14.88 (part a)

Dividend 0 = $0.64

Required Return = 8.9%

Growth Rate = ?

So,

$14.88 = $0.64 + G/(8.9%-G)

$14.88(8.9%-G) = $0.64 + G

$1.3243- 14.88 G =$0.64 + G

14.88G + G = $1.3243 - $0.64

15.88G = 0.6843

G = 0.6843/15.88

G = .0431 or 4.31%

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