Question

1. BLUECHIP PLC just paid a dividend of $2.00 per share. The managing director just announced that it is planned to increase dividends at a rate of 6% indefinitely. An appropriate discount rate for this company is 16% per annum.

1. What is the firm’s expected dividend stream over the next 3 years?   
2. What is the firm’s current stock price?
3. What is the firm’s expected value in one year?

d.What is the expected dividend yield, capital gains yield and total return during the first year?                                                                                                                            

Answer 1

a. Expected dividend in next year = $2.00*1.06 = $2.12

Expected dividend in 2nd year = $2.00*1.06*1.06 = $2.2472

Expected dividend in 3rd year =$2.00*1.06*1.06*1.06 = $2.3820

b. The current stock price P is found using Dividend discount model

where is the next year's dividend = $2.12

r is the required return = discount rate = 16%

g is the growth rate of dividends indefinitely = 6%

P = 2.12/ (0.16-0.06) = 21.2

Hence, the firm’s current stock price = $21.2

c. Firm's expected value in a year

Firm's expected value in a year = 2.2472/ (0.16-0.06) = 22.472

Hence, the firm’s expected value in one year = $22.472

d. Current dividend yield = Most recent dividend payment / Current stock price

Current dividend yield = 2.00/21.2 = 9.434%

Capital gains yield = (22.472-21.2)/21.2 = 6.00%

Total return =(Capital gains+dividend) / Initial stock price = (22.472-21.2+2)/21.2

Total return = 15.434% ( which is also equal to Current dividend yield+Capital gains yield)