Question

The Happy Holiday Touring Company has developed a novel way of selling vacation packages. The company would like to promote this idea over the next few years before the competition creates their own vacation clubs, however there is some concern regarding a projected recession and the effect this may have on their share price.

Earnings and dividends are expected to grow at a rate of 1% in the first year, -2% in the

second year and at a constant rate of 3% thereafter. The required rate of return for this

industry is 5%. Last year, the company paid a dividend of $1.10 per share.

(Timeline required.)

Required:

(***Carry all decimal places. Round final answers to 2 decimal places.)

(1) What is the price of Happy Holiday Touring Company shares today?

(2) What is the share price (estimated) at the end of the first year?

(3) What dividend yield, capital gains yield, and total yield, should an investor in this company expect for the first year?

Answer 1

Answer:

Where

P = Current share price

D₁ = value of next year's dividend

r = Expected rate of return

g = growth rate of dividends

1) Share price of Happy Holiday Touring Company today:

D₁ = value of next year's dividend = last year dividend + growth rate

= $ 1.1 per share + 1%

= $ 1.111 per share

r = Expected rate of return = 5%

g = growth rate of dividends = 1%

Price of Happy Holiday Touring Company shares today is $ 27.78 per share.

2) Estimated share price at the end of first year:

D₂ = value of next year's dividend = last year dividend + growth rate

= $ 1.111 per share - 2%

= $ 1.08878 per share

r = Expected rate of return = 5%

g = growth rate of dividends = -2%

Estimated share price of Happy Holiday Touring Company at the end of first year is $ 15.55 per share.

3) Yield in the first year:

Dividend yield = Dividend per share / Market Price per share

=1.111/ 27.775

= 4%

Capital gain yield = (P₁-P_{0) /} P₀

= (15.554 - 27.775) / 27.775

= - 44 %

Total yield = Dividend yield + Capital gain yield = 4% - 44% = - 40% = (40)%

The investor would get a negative 40% total yield in the first year.