Question

Question 1:

Assume that it is now January 1, 2010. ABC is experiencing is using all the earnings for expansion and therefore, has no dividends. The company will pay a dividend of $1.5 coming 4 years from today. The dividends are expected to grow at a super-normal growth rate of 20% for year 5 and year 6, after which the company achieves a long run growth rate of 6%. Stockholders require a return of 12%.

a. Calculate ABC's non-constant dividends from year 1 to year 6. Also make a time-line.

b. Calculate ABC's horizon value.

c. Calculate the value of the stock today, P̂0.

d. Calculate the expected dividend yield, capital gains yield, and total return expected for 2010.

Answer 1

a. Timeline

Dividend Payment Schedule
Year	Dividend	Growth Rate
1	1.50	-
2	1.50	-
3	1.50	-
4	1.50	-
5	1.80	20%
6	2.16	20%
7	2.29	6% (Constant thereafter)

b. Calculation of ABC's Horizon Value

The value of share of a company at the point after which we expect stable growth rate forever i.e P6.

Therefore, the Horizon Value is $38.16.

c. Calculation of Value of stock today:

To calculate the price of stock today, we need to discount the horizon value and dividends from Year 1-6 today that is January 1, 2010.

Present Value Schedule
Year	Dividend	Horizon Value	Present Value Factor @ 12%	Present Value
1	1.50	-	0.892857143	1.34
2	1.50		0.797193878	1.20
3	1.50		0.711780248	1.07
4	1.50		0.635518078	0.95
5	1.80		0.567426856	1.02
6	2.16	38.16	0.506631121	20.43
				26.00

d.

• Expected Dividend Yield for the year 2010:

Therefore Expected Dividend Yield is 5.77%

• Capital Gains yield

Expected price of Stock on January 1,2011.

Present Value Schedule
Year	Dividend	Horizon Value	Present Value Factor @ 12%	Present Value
1	1.50		0.892857143	1.34
2	1.50		0.797193878	1.20
3	1.50		0.711780248	1.07
4	1.80		0.635518078	1.14
5	2.16	38.16	0.567426856	22.88
				27.63

Therefore, Capital gains yield will be 6.27%.

• Total return Expected for Year 2010:

Therefore, Total return expected for the Year 2010 will be 12.04%.