Question

Use the Excel Template and the following information to answer the next three questions: Peterson Packaging Inc. does not currently pay dividends. The company will start with a $0.50 dividend at the end of year three and grow it by 10% for each of the next seven years until it nearly reaches $1.00. After seven years of growth, it will fix its dividend at $1.00 forever. The required return on the stock is 15%.

1. (EXCEL TEMPLATE) What is the current stock price? Use the NPV function.

2. (EXCEL TEMPLATE) What is the expected stock price in years 1-10? Use the NPV function.

3. (EXCEL TEMPLATE) Calculate the dividend yield and capital gains yield that an investor should expect for each year.

Answer 1

Year	Dividend	Price	Div. yield	Cap gains
0		$3.91
1	$          -	$4.50	0.00%	15.00%
2	$          -	$5.17	0.00%	15.00%
3	$      0.50	$5.45	9.18%	5.82%
4	$      0.55	$5.71	9.62%	5.38%
5	$      0.61	$5.97	10.14%	4.86%
6	$      0.67	$6.20	10.74%	4.26%
7	$      0.73	$6.39	11.45%	3.55%
8	$      0.81	$6.55	12.30%	2.70%
9	$      0.89	$6.64	13.33%	1.67%
10	$      0.97	$6.67	14.62%	0.38%
11	$      1.00

First, forecast the future dividends given the growth rate.

D3 = 0.5, D4 = 0.5 x (1 + 10%) = 0.55 and so on.. D11 = 1.00

Price in year 10, P10 = D11 / r = 1 / 15% = $6.67

Price in year 9, P9 = (D10 + P10) / (1 + r) = (0.97 + 6.67) / 1.15 = $6.64 and so on...

Dividend yields = Dn / Pn => Div yield in year 10 = 0.97 / 6.67 = 14.62%

Capital gains = 15% - dividend yields