XYZ Inc. has expected earnings over the next year of $2/share (E1=2). the compan

Question

XYZ Inc. has expected earnings over the next year of $2/share (E1=2). the company is expected to maintain an earnings retention rate of 40%, i.e., 60% of earnings are expected to be [aid out as dividends every year. The company has a beta of 1.5, the risk-free rate is 4%, and the market risk premium is also 4%. If the growth rate in earnings is expected to be 5% in perpetuity, what's the expected holding period return over the next year? How much of the return is due to capital gains (price appreciation = P1/P0 - 1) and how much s attribute to dividend yield (D1/P0)?

Explanation / Answer

Ke= 4+1.5x4= 10% Earning= $2 Therefor Dividend= .6x2= 1.2 P0= 1.2/(.1-.05)= $24 P1= 1.2x1.05/(.1-.05)= 25.2 return is due to capital gains= (25.2/24)-1= 5% dividend yield= 1.2/24= 5%

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