Question

a. Assume that Bon Temps’ stock is currently selling at $21.20. What is the expected rate of return on the stock?

b. What would the stock price be if its dividends were expected to have zero growth?

c. Assume that Bon Temps is expected to experience supernormal growth of 30% for the next 3 years, then to return to its long-run constant growth rate of 6%. What is the stock’s value under these conditions? What are its expected dividend yield and its capital gains yield in Year 1? In Year 4?

d. Suppose Bon Temps is expected to experience zero growth during the first three years and then to resume its steady-state growth of 6% in the fourth year. What is the stock’s value now? What are its expected dividend yield and its capital gains yield in Year 1? In Year 4?

e. Assume that Bon Temps’ earnings and dividends are expected to decline by a constant 6% per year—that is, g = 26%. Why might someone be willing to buy such a stock, and at what price should it sell? What would be the dividend yield and capital gains yield in each year?

I just need help with letter E. I have already answered A-D. Thanks.

Answer 1

As required, I have answered question Part e with all the relevant details and formulas.

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Part e)

An investor would be willing to buy the stock because the company is having a value that is greater than 0. This is evident from the fact that it is earnings profits and still paying dividends out of it even though it has a negative growth rate of 6%.

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The price at which the stock should sell is calculated as below:

Price at which Stock should Sell = Dividend*(1+Growth Rate)/(Required Return on Stock - Growth Rate)

Here, Dividend = 2%, Growth Rate = -6% and Required Return on Stock = 13%

Substituting these values in the above formula, w eget,

Price at which Stock should Sell = 2*(1-6%)/(13%- (-6%)) = $9.89

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The value of dividend yield and capital gains yield is determined as follows:

Capital Gains Yield = Growth Rate = -6% (it is because the stock is a constant growth stock)

Dividend Yield = Required Return - Capital Gains Yield = 13% - (-6%) = 19%

Dividend Yield can also be calculated as below:

Dividend Yield = Annual Dividend/Current Stock Price*100 = 2*(1-6%)/9.89*100 = 19% (same as above)