Question

# 2. A company paid out a dividend of \$3 today (Div0). The company’s dividends are paid once a year (next dividend

is in a year from today) and are expected to grow at a constant growth rate of 4% annually, forever. The company’s equity sensitivity to market risk (i.e. the stock beta) is 1.5. It is known that the risk free rate, f r , is 2.5% and the market risk premium, ( ) E r r m f  , is 5%.

a. Calculate the expected stock return by using the CAPM model.

b. What is the price of the stock today?

c. What is the price of the stock exactly three years from today (just after a dividend is paid out)? Hint – find the dividend in year 4, Div4 to compute the price in three years.

d. Calculate the dividend yield for the stock today. Hint – this is based on today’s stock price and the upcoming dividend, Div1.

e. Calculate the dividend yield for the stock 3 years from today. Assume you bought the stock today for the price calculated in section b. and sold it after 3 years at the price calculated in section c. Obviously, don’t forget that as a stock owner, you also received 3 dividend payments during these three years (last dividend just before you sold the stock). 2 Property of: Mor M. Haziza. Managerial Finance; UCI 2018-2019

f. Calculate your annual yield just from capital gains on this deal. Hint – to do that, forget for this section that you received dividends and set these to 0. Just use the buy price (at t=0) and sale price (at t=3). Plug these cash flows into CASH to compute the IRR or solve for IRR in a hand written calculation (remember IRR is the interest rate that ‘ties’ together what you pay and what you get).

g. Calculate your annual total return from this deal. Hint – repeat section f. this time include all the cash flows involved (Buy price, all dividends received during the period and sale price).

h. Summarize your resus to sections d. – g. on the dividend yield, capital gain yield and the return from both. Please explain.

Managerial Accounting