Start with the partial model in the file Ch08 P24 Build a Model.xlsx on the text

Question

Start with the partial model in the file Ch08 P24 Build a Model.xlsxon the textbook’s Web site. Hamilton Landscaping’s dividend growth rate is expected to be 30% in the next year, drop to 15% from Year 1 to Year 2, and drop to a constant 5% for Year 2 and all subsequent years. Hamilton has just paid a dividend of $2.50, and its stock has a required return of 11%.

a. What is Hamilton’s estimated stock price today?

b. If you bought the stock at Year 0, what are your expected dividend yield and capital gains for the upcoming year?

c. What are your expected dividend yield and capital gains for the second year (from Year 1 to Year 2)? Why aren’t these the same as for the first year?

Explanation / Answer

As per Dividend growth Model, Market value of Equity(ex-dividend) = Current Dividend(1+ expected continuous dividend growth rate)/(Required Equity return rate or cost - expected continuous dividend growth rate) Year 0 Year 1 Year 2 Year 3 &Perpetual Dividend growth 30% 15% 5% Dividend expected $ 2.5 3.250 3.738 3.924 Required rate of return 11% Discounting factor @11% 1 0.9009 0.8116 0.7312 Share value after year 2 =3.924*1.05/(0.11-0.05)= 68.67 Dividends and share prices 2.50 3.25 3.74 72.59 PV of dividends & share value 2.5 2.928 3.033 53.080 Total of PV         61.54 a So Hamilton's share price today is $61.54 b Share value expected after purchase at year 0 = 3.25*1.15/0.04 2.500 93.4375 PV of dividends and share value at year 1 2.5 84.177928 Total PV at year 1         86.68 Share price at Year 1 end         86.68 Current price 61.54 So capital gain in upcoming Year         25.14 Dividend yield in upcoming year =3.250/86.68= 3.75% c Share value expected at year 2 =3.738(1.05)/0.06 = 65.415 Share price at Year 1 end         86.68 So Capital Loss      (21.27) Dividend yield in year 2 =3.738/65.415 5.71% d The dividend yield and capital gains are different as in the second year onwards the dividend growth projection reduced to 5% from 15% of previous year.So share value went doen resulting un capital loss. The dividend increaed by 5% over prev year , but the share price went down in the current year ,. So dividend yiled shows an increase in year 2

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