You buy a share of The Ludwig Corporation stock for $23.10. You expect it to pay

Question

You buy a share of The Ludwig Corporation stock for $23.10. You expect it to pay dividends of $1.00, $1.15, and $1.3225 in Years 1, 2, and 3, respectively, and you expect to sell it at a price of $30.66 at the end of 3 years.

Calculate the growth rate in dividends. Round your answer to two decimal places.
%

Calculate the expected dividend yield. Round your answer to two decimal places.
%

Assuming that the calculated growth rate is expected to continue, you can add the dividend yield to the expected growth rate to obtain the expected total rate of return. What is this stock's expected total rate of return? Round your answer to two decimal places.
%

Explanation / Answer

Part 1)

Since, the growth rate is assumed to be constant, we can calculate the growth rate of dividends with the use of following formula:

Growth Rate (G1) = (Dividend in Year 2 - Dividend in Year 1)/Dividend in Year 1*100

or

Growth Rate (G2) = (Dividend in Year 3 - Dividend in Year 2)/Dividend in Year 2*100

_________

Using the values provided in the question, we get,

Growth Rate (G1) = (1.15 - 1)/1*100 = 15%

Growth Rate (G2) = (1.3225 - 1.15)/1.15*100 = 15%

Therefore, growth rate is 15% only.

_____________

Part B)

Dividend yield in the ratio of annual dividend to the current selling/market price of the same. The formula for calculating dividend yield is:

Dividend Yield = Annual Dividend/Current Price Per Share*100

_________

Using the values provided in the question, we get,

Dividend Yield = 1/23.10*100 = 4.33%

_____________

Part C)

The total expected return is the sum of dividend yield and growth rate (assuming it remains constant). The formula would be:

Expected Total Rate of Return = Dividend Yield + Growth Rate (this is similar to Gordon's dividend growth model)

_________

Using the values calculated in Part A) and Part B), we get,

Expected Total Rate of Return = 4.33% + 15% = 19.33%

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