Question

High Country Builders currently pays an annual dividend of $1.35 and plans on increasing that amount by 3.5 percent each year. Valley High Builders currently pays an annual dividend of $1.20 and plans on increasing its dividend by 3 percent annually. Given this information, you know for certain that the stock of High Country Builders' has a higher ______ than the stock of Valley High Builders.

A. Total Rate of Return

B. The answer cannot be determined on the information provided

C. Dividend yield

D. Market Price

E. Capital Gains Yield.

I've seen answers to this be both capital gains yield and the answer cannot be determined (citing missing required rate of return)

Help?

Answer 1

Given for High country Builders,

D0 = $1.35

growth rate g = 3.5%

let required return be Rh

Then stock price using constant dividend growth model is

P0 = D0*(1+g)/(Rh-g) = 1.35*1.035/(Rh - 0.035) = 1.397/(Rh-0.035)

so, its total return = Rh

dividend yield = D1/P0 = D0*(1+g)/P0 = 1.35*1.035/(1.397/(Rh-0.035)) = Rh - 0.035

capital gain yield = total return - dividend yield = (Rh - (Rh - 0.035)) = 3.5%

Similary for Valley high builder

D0 = $1.2

growth rate g = 3%

let required return be Rv

Then stock price using constant dividend growth model is

P0 = D0*(1+g)/(Rv-g) = 1.2*1.03/(Rv - 0.03) = 1.236/(Rv-0.030)

so, its total return = Rv

dividend yield = D1/P0 = D0*(1+g)/P0 = 1.2*1.03/(1.236/(Rv-0.03)) = Rv - 0.03

capital gain yield = total return - dividend yield = (Rv - (Rv - 0.03)) = 3%

So, it is certain that, Capital gain yeild of Hish country builders is higher than that of valley high builders. and since Required return is not given for both, it is difficult to comment on other factors.

So, Given this information, you know for certain that the stock of High Country Builders' has a higher capital gain yield than the stock of Valley High Builders. Option E is correct.