Nonconstant growth stock valuation Taussig Technologies Corporation (TTC) has be

Question

Nonconstant growth stock valuation

Taussig Technologies Corporation (TTC) has been growing at a rate of 14% per year in recent years. This same growth rate is expected to last for another 2 years, then decline to gn = 4%.

A. If D0 = $2.30 and rs = 12.00%, what is TTC's stock worth today? Round your answer to the nearest cent.

B. What is its expected dividend yield at this time, that is, during Year 1? Round your answer to two decimal places.

C. What is its capital gains yields at this time, that is, during Year 1? Round your answer to two decimal places.

What will TTC's dividend and capital gains yields be once its period of supernormal growth ends? (Hint: These values will be the same regardless of whether you examine the case of 2 or 5 years of supernormal growth; the calculations are very easy.)
Round your answers to two decimal places.

Dividend yield?

Capital gains yield?

Explanation / Answer

Part A:

D0 = $2.30; rs = 12% ; g=14% for the first two years and gn = 4% after 2 years

D1 = 2.30 (1+0.14) = $2.622

D2 = 2.622 (1+0.14) = $ 2.989

D3 = 2.989 (1 + 0.04) = $ 3.109

P0 = Present value of dividend for the explicit growth period of two years + present value of the share at the end of the explicit growth period

= D1/(1+rs) + D2 / (1+rs)^2 + P2 / (1+rs)^2, where P2 = D3/(rs - gn) = $3.109 / (0.12 - 0.04) = $38.863

= 2.622/ (1+0.12) + 2.989/ (1+0.12)^2 + [3.109/(0.12 - 0.04)]* [1/(1+0.12)^2]

=2.341 + 2.383 + 30.981

= $35.71 (approx)

Part B:

Expected Dividend Yield = D1 / P0 = $2.622 / $35.71 = 0.07 (approx)

Part C:

P0 = Pv of the first year dividend + Pv of the price at the end of Year 1

= 2.622 / 1.12 + P1 / 1.12

=> 35.71 = (2.622 + P1) / 1.12

=> P1 + 2.622 = 1.12 * 35.71 = 39.995

=> P1 = $37.373

Therefore Capital Gain Yield = (P1 -P0) / P0 = (37.373 - 35.71) / 35.71 = 0.05 (aaprox)

Check: Dividend yield + capital gain yield = 0.07 + 0.05 = 0.12 = 12% = rs

Throughout the supernormal growth period, the total yield, rs, will be 12%, but the dividend yield is relatively low during the early years of the supernormal growth period and the capital gains yield is relatively high. As we near the end of the supernormal growth period, the capital gains yield declines and the dividend yield rises. After the supernormal growth period has ended, the capital gains yield will equal gn = 4%. The total yield must equal rs = 12%, so the dividend yield must equal 12%

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