Question

Sam Forbes and Jenny Hewes are senior vice-presidents of the First Creek Investment Council . They are co-directors of the company's pension fund management division, with Sam having responsibility for fixed income securities (primarily bonds) and Jneey being responsible for equity investments. A major new client has requested that council present an investment seminar to Executive Committee, and Forbes and Hewes, who will make the actual presentation, have asked you, a recent UCW graduate to help them.                                                                                                       

to illustrate the common stock valuation process, Sam and Jenny have asked you to analyze the Temp Force Company, an employment agency that supplies word processor operators and computer programmers to businesses with temporarily heavy workloads. You are to answer the following questions. the required rate of return in of the firm's stock is 11.8%.   Assume that Temp Force is a constant growth company whose last dividend (Do, which was paid yesterday) was $2.00, and whose dividend is expected to grow indefinitely at a 5 percent rate.            

c. Now assume that the stock is currently selling at $43.75. What is the expected rate of return on the stock?   

                                                                                                    

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

g. Now assume that Temp Force is expected to experience supernormal growth of 30 percent for the next 3 years, then to return to its long-run constant growth rate of 5 percent. What is the stock's value under these conditions? What is its expected dividend yield and capital gains yield in Year 1? In Year 4?              

Answer 1

c. Now assume that the stock is currently selling at $43.75. What is the expected rate of return on the stock?

Expected rate of return = [Dividend Now * (1 + Growth rate) / Stock price] + Growth rate

Expected rate of return = [$2 * (1 + 5%) / 43.75] + 5%

Expected rate of return = 4.80% + 5%

Expected rate of return = 9.80%

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

Stock price = Current Dividend / Required rate of return = $2 / 11.80%

Stock price = $16.95

g. Now assume that Temp Force is expected to experience supernormal growth of 30 percent for the next 3 years, then to return to its long-run constant growth rate of 5 percent. What is the stock's value under these conditions? What is its expected dividend yield and capital gains yield in Year 1? In Year 4?

Stock price Now = $56.73

Dividend Yield in year 1 = Current Dividend / Share price

Dividend Yield in year 1 = $2 / $56.73

Dividend Yield in year 1 = 3.53%

Capital gains Yield in year 1 = required rate of return - dividend yield

Capital gains Yield in year 1 = 11.80%-3.53%

Capital gains Yield in year 1 = 8.27%

Dividend Yield in year 4 = Dividend in year 3 / Share price in year 3

Dividend Yield in year 4 = 4.39 / 67.85

Dividend Yield in year 4 = 6.48%

Capital gains Yield in year 4 = required rate of return - dividend yield

Capital gains Yield in year 4 = 11.80%-6.48%

Capital gains Yield in year 4 = 5.32%

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