Suppose a company has net income of 1,000,000 and a plowback ratio of 40%. There

Question

Suppose a company has net income of 1,000,000 and a plowback ratio of 40%. There are 50,000 shares of stock outstanding. The comany plans to increase dividends by 22% each year for the next 2 years and apply a 2.25% growth rate to dividends each year indefinitely. The required return is 13%. What will this year's dividend be? What should the stock price be today? What is this years dividend yield? What is this year's capital gains yield? What will the stock be in 2 years? What will dividend yield and capital gains yield be in 2 years?

Explanation / Answer

dividend per share = 600,000/50,000 = 12 ( net income - plowback profits)/number of shares outstanding

required rate of return = 13%

price of the stock today = dividend/required rate of return

= 12/13% = $92.31

Stock price after 2 years = Dividend/r-g whwre r is the rate of return and g is growth rate

dividend after 2 years would be = 12*(1+22%)^2 = 17.86

price of stock = 17.86/13%-2.25%

= $137.37

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