In: Accounting
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.
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.
Therefore Expected Dividend Yield is 5.77%
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%.
Therefore, Total return expected for the Year 2010 will be 12.04%.