A stock is expected to pay a year-end dividend of $2.00, i.e., D1 = $2.00. The d

Question

A stock is expected to pay a year-end dividend of $2.00, i.e., D1 = $2.00. The dividend is expected to decline at a rate of 5% a year forever (g =-5%). If the company is in equilibrium and its expected and required rate of return is 15%, which of the following statements is CORRECT? The company's current stock price is $20. The company's expected capital gains yield is 5%. The company's dividend yield 5 years from now is expected to be 10%. The constant growth model cannot be used because the growth rate is negative. The company's expected stock price at the beginning of next year is $9.50.

Explanation / Answer

Stock price = D1÷(r-g)

D1 is next expected dividend

r is required return

g is growth rate

= $2÷(15%+5%)

= $10

Stock price next year:

= $2×(1-5%)÷(15%+5%)

= $9.5

Hence, correct option is The company's expected stock price at the beginning of next year is $9.50.

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