Question

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Dolemite mines just paid a dividend of $5.50, its dividends are expected to grow at 4.00%...

Dolemite mines just paid a dividend of $5.50, its dividends are expected to grow at 4.00% forever. Investors required return on the stock is 7.50%.

What is Dolemite's dividends for the next two years?

If you were going to buy the stock today and sell it next year, at what price would you expect to sell the stock for, assuming the growth rate and required return remains unchanged?

Stock Price in Year 1: ??

What is the present value of next year's dividend and the selling price?


Today's Present Value of the Dividend
Today's Present Value of the Stock price next year
Total Present Value of Dividends and Stock Price

What is Dolemite's stock price using the constant dividend growth model?

What is the growth rate of the stock price from today to next year?

What is the dividend yield on the stock?

What is the investor expected return for holding the stock over the next year?

Solutions

Expert Solution

Answer a.

Last Dividend, D0 = $5.50
Growth Rate, g = 4.00%
Required Return, rs = 7.50%

Dividend in Year 1, D1 = D0 * (1 + g)
Dividend in Year 1, D1 = $5.50 * 1.04
Dividend in Year 1, D1 = $5.72

Dividend in Year 2, D2 = D1 * (1 + g)
Dividend in Year 2, D2 = $5.72 * 1.04
Dividend in Year 2, D2 = $5.9488

Answer b.

Stock Price in Year 1, P1 = D2 / (rs - g)
Stock Price in Year 1, P1 = $5.9488 / (0.075 - 0.040)
Stock Price in Year 1, P1 = $169.97

Answer c.

Present Value of Next Year’s Dividend = D1 / (1 + rs)
Present Value of Next Year’s Dividend = $5.72 / 1.075
Present Value of Next Year’s Dividend = $5.32

Present Value of Next Year’s Stock Price = P1 / (1 + rs)
Present Value of Next Year’s Stock Price = $169.97 / 1.075
Present Value of Next Year’s Stock Price = $158.11

Total Present Value of Dividends and Stock Price = Present Value of Next Year’s Dividend + Present Value of Next Year’s Stock Price
Total Present Value of Dividends and Stock Price = $5.32 + $158.11
Total Present Value of Dividends and Stock Price = $163.43

Answer d.

Current Stock Price, P0 = D1 / (rs - g)
Current Stock Price, P0 = $5.72 / (0.075 - 0.040)
Current Stock Price, P0 = $163.43

Answer e.

Growth Rate in Stock Price = (P1 - P0) / P0
Growth Rate in Stock Price = ($169.97 - $163.43) / $163.43
Growth Rate in Stock Price = 4.00%

Answer f.

Dividend Yield = D1 / P0
Dividend Yield = $5.72 / $163.43
Dividend Yield = 3.50%

Answer g.

Expected Return = Growth Rate + Dividend Yield
Expected Return = 4.00% + 3.50%
Expected Return = 7.50%

jeff jeffy answered 1 year ago

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