Question

Nonconstant Growth Stock Valuation

Conroy Consulting Corporation (CCC) has been growing at a rate of 20% per year in recent years. This same non-constant growth rate is expected to last for another 2 years (g0,1 = g1,2 = 20%).

If D0= $1.10, rs= 12% and gL = 8%, then what is CCC's stock worth today? Round your answer to the nearest cent. Do not round your intermediate computations.

$   

What is its expected dividend yield at this time? Round the answer to two decimal places. Do not round your intermediate computations.

     %

What is its capital gains yields at this time? Round the answer to two decimal places. Do not round your intermediate computations.

     %

Now assume that CCC's period of supernormal growth is to last another 5 years rather than 2 years (g0,1 = g1,2 = g2,3 = g3,4 = g4,5 = 20%). How would this affect its price, dividend yield, and capital gains yield?
-Select-IIIIIIIVVItem 4
I.Due to the longer period of supernormal growth, the value of the stock will be higher for each year. The total return as well as the distribution between dividend yield and capital gains yield will differ for the duration of the supernormal growth period.
II.Due to the longer period of supernormal growth, the value of the stock will be higher for each year. The total return as well as the distribution between dividend yield and capital gains yield will remain the same for the duration of the supernormal growth period.
III.Due to the longer period of supernormal growth, the value of the stock will be lower for each year. The total return as well as the distribution between dividend yield and capital gains yield will differ for the duration of the supernormal growth period.
IV.Due to the longer period of supernormal growth, the value of the stock will be higher for each year. Although the total return will remain the same, the distribution between dividend yield and capital gains yield will differ for the duration of the supernormal growth period.
V.Due to the longer period of supernormal growth, the value of the stock will be lower for each year. Although the total return will remain the same, the distribution between dividend yield and capital gains yield will differ for the duration of the supernormal growth period.

What will CCC's dividend yield and capital gains yield be once its period of supernormal growth ends? (Hint: These values will be the same regardless of whether you examine the case of 2 or 5 years of supernormal growth, and the calculations are very easy.) Round the answers to two decimal places. Do not round your intermediate computations.

Dividend yield	%
Capital gains yield	%

Of what interest to investors is the relationship over time between dividend yield and capital gains yield?
-Select-IIIIIIIVVItem 7
I.Some investors need cash dividends, while others would prefer growth. Also, investors must pay taxes each year on the dividends received during the year, while taxes on the capital gain can be delayed until the gain is actually realized.
II.Some investors need cash dividends, while others would prefer growth. Also, investors must pay taxes each year on the capital gain during the year, while taxes on the dividends can be delayed until the stock is sold.
III.It is of no interest to investors whether they receive dividend income or capital gains income, since both types of income are always taxed at the same rate.
IV.It is of no interest to investors whether they receive dividend income or capital gains income, since taxes on both types of income must be paid in the current year.
V.It is of no interest to investors whether they receive dividend income or capital gains income, since taxes on both types of income can be delayed until the stock is sold.

Answer 1

D0	$        1.10
D1	$        1.32
D2	$        1.58
D3	$        1.71
P2	$      42.77
P0	$      36.54

D1 = D0 x (1 + gs) = 1.1 x (1 + 20%) = 1.32, D2 = 1.32 x (1 + 20%) = $1.58, D3 = 1.58 x (1 + 8%) = $1.71

Price in year 2, P2 = D3 / (r - g) = 1.71 / (12% - 8%) = $42.77

Price today, P0 = D1 / (1 + r) + (D2 + P2) / (1 + r)^2 = 1.32 / 1.12 + (1.58 + 42.77) / 1.12^2 = $36.54

Expected Dividend Yield = D1 / P0 = 1.32 / 36.54 = 3.61%

Expected Capital Gains = 12% - 3.61% = 8.39%

IV is correct. The stock price will be higher but dividend yields and capital gains will be different.

After supernormal growth period, Dividend Yield = D1 / P0 = r - g = 12% - 8% = 4%

Capital Gains = 12% - 4% = 8%

I is correct. Capital Gains are taxed when realized while dividends are taxed annually.