Question

Stock ABC recently paid a dividend of $1.15 per share. The dividend growth rate is expected to be 4.20% indefinitely. Stockholders require a rate of return of 11% on this stock. If the stock trades at a price of $16.7, what will your holding period return be if you buy it now and sell it after 2 years for the intrinsic value according to the constant growth dividend discount model?

Answer 1

D1 = 1.15(1+4.2%) = 1.1983

D2 = 1.1983(1+4.2%) = 1.2486

D3 = 1.2486(1+4.2%) = 1.3011

 

price at year 2 = D3 / (r-g)

                           = 1.3011 / (0.11-0.042)

                           = $19.13

 

Holding period return = [end value + dividends received - purchase price] / purchase price

                                        = [19.13+1.1983+1.2486 - 16.7] / 16.7

                                        = 29.2%

 

Holding period return is 29.2%.