Question

The Duo Growth Company just paid a dividend of $1.00 per share. The dividend is expected to grow at a rate of 23% per year for the next three years and then to level off to 5% per year forever. You think the appropriate market capitalization rate is 18% per year.

a. What is your estimate of the intrinsic value of a share of the stock? (Use intermediate calculations rounded to 4 decimal places. Round your answer to 2 decimal places.)

b. If the market price of a share is equal to this intrinsic value, what is the expected dividend yield? (Use intermediate values rounded to 2 decimal places. Round your answer to 4 decimal places.)

c. What do you expect its price to be one year from now? (Use intermediate values rounded to 4 decimal places. Round your answer to 2 decimal places.)

d-1. What is the implied capital gain? (Use intermediate values rounded to 2 decimal places. Round your answer to 4 decimal places.)

d-2. Is the implied capital gain consistent with your estimate of the dividend yield and the market capitalization rate?

Answer 1

a.

Intrinsic value of a share of the stock is calculated in excel and screen shot provided below:

Current Stock price is $12.41.

b.

Dividend Yield = Expected dividend / Current Stock price

= $1.23 / $12.41

= 9.91%

Dividend Yield is 9.91%.

c.

Stock price one year from now is calcullated in excel and screen shot provided below:

Stock price one year from now will be $13.41.

Capital gain = $13.41 - $12.41

$1.00

Capital gain is $1.00

Capital gain yield = ($13.41 - $12.41) / $12.41

= $1. / $12.41

= 8.09%

Capital gain yield is 8.09%.

Total return = Dividend yield + Capital gain yield

= 9.91% + 8.09%

= 18%

Total return is 18% which is equal to market capitalization rate.