Question

Airnova Inc. is considering four different types of stocks. They each have a required return of 20 percent and a dividend of $3.75 for share. Stocks, A, B, and C are expected to maintain constant growth rates in dividends for the near future of 10 percent, 0 percent, and -5 percent, respectively. Stock D is a growth stock and will increase its dividend by 30 percent for the next four years and then maintain a constant 12 percent growth rate after that. Please answer with the formula used.

What is the dividend yield for each of the four stocks?

Answer 1

To calculate dividend yields of each stock, first we need to find the prices of each share.

Price of stock A(Pa)=Dividend next year(D1)/(required return-growth rate)

D1=3.75*(1+10%)=$4.125

Price of stock A =4.125/(20%-10%)=$41.25

Price of stock B (PB)=(3.75*(1+0))/(20%-0%)=$18.75

Price of stock C (PC)=(3.75*(1-5%))/(20%-(-5%))=$14.25

Price of stock D (PD)=(D1/(1+r))+(D2/(1+r)^2)+(D3/(1+r)^3)+(D4+Terminal value at year4)/(1+r)^4

D1=3.75*(1+30%)=4.875

D2=4.875*(1+30%)=6.3375

D3=6.3375*(1+30%)=8.23875

D4=8.23875*(1+30%)=10.71038

D5=10.71038*(1+12%)=11.99562

Terminal value at year4=D5/(r-g)=11.99562/(20%-12%)=$149.9453

Price of stock D=(4.875/1.2)+(6.3375/1.2^2)+(8.23875/1.2^3)+(10.71038+149.9453)/1.2^4

Price of stock D=$90.71

Dividend yield of stock A=Dividend/share price=3.75/41.25=9.09%

Dividend yield of stock B=3.75/18.75=20%

Dividend yield of stock C=3.75/14.25=26.3%

Dividend yield of stock D=3.75/90.71=4.13%