suppose a company has net income of $1,000,000 and a plowback ratio of 40%. ther

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 company plans to increase dividends by 22% each year for the next 2 years and then apply a 2.25% growth rate to dividends each year indefinitely. the required return is 13%. what will this years dividend be, what should the stock price be today, what is this years dividend yield, what is this years capital gains yield, what will the stock price be in 2 years, what will dividend yield and capital gains yield be in 2 years

Explanation / Answer

This year's dividend = 60% of $1000000 = $600000

Dividend per share = $600000/ 50000 = $12

Stock price today = Dividend per share/ required rate of return

= 12 /0.13 = $92.31

Dividend yield = Dividend per share/ stock price

= 12/ 92.31 = 12.99 say 13%

Capital gains yield = (selling price - stock price)/ selling price

= (20- 92.31)/ 92.31

= -7.83%

where, Selling price = Net income/ total no. of outstanding shares

= 1000000/ 50000

=$20

Dividend per share in next year = 12 + (12*22%) = $14.64

Dividend per share in 2 years = 14.64 + (14.64 *2.25%) = $14.97

Stock price in 2 years = 14.97/ 0.13-0.0225 = $139.26

Dividend yield = 14.97/ 139.26 = 10.75%

Capital gains yield = (20 - 139.26)/ 139.26 = -8.56%

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