Normal tea companies grow at a constant rate of 5%. However, Taya\'s Tea company

ID: 2755056 • Letter: N

Question

Normal tea companies grow at a constant rate of 5%. However, Taya's Tea company has tested a brand new tea that will lead to signfiicant growth. The current dividend is $3.0, but over the next two years it will grow by 25%. By year 3, expectations are that Taya's Tea company will revert to the mean with 4% growth. Taya's current beta is 2, with a risk-free rate of 2%, and the market risk premium at 5%. What is Taya's Tea company expected dividend stream over the next three years? What is the current stock price? What is the dividend yield, the capital gains yield, and the total return during the first year? If Taya's shares were trading at $10 per share, would you buy? Normal tea companies grow at a constant rate of 5%. However, Taya's Tea company has tested a brand new tea that will lead to signfiicant growth. The current dividend is $3.0, but over the next two years it will grow by 25%. By year 3, expectations are that Taya's Tea company will revert to the mean with 4% growth. Taya's current beta is 2, with a risk-free rate of 2%, and the market risk premium at 5%. What is Taya's Tea company expected dividend stream over the next three years? What is the current stock price? What is the dividend yield, the capital gains yield, and the total return during the first year? If Taya's shares were trading at $10 per share, would you buy?

Explanation / Answer

Normal tea companies grow at a constant rate of 5%.

Taya's Tea company expected dividend stream over the next three years:

The current dividend(D0)= $3.0

growth in next 2 years=25%

dividend in year 1(D1)=$3+25%=$3.75

dividend in year 2(D2)=$3.75+25%=$4.6875

By year 3, expectations are

that Taya's Tea company will revert to the mean with 4% growth.

dividend in year 3(D3)=$4.6875+4%=$4.875

Beta= 2

risk-free rate(rf) = 2%

market risk premium(rf-rm) at 5%.

cost of equity (re)= rf+(rf-rm)beta

=2%+(5%*2)

=12%

calculation of current stock price:

price in year 2=d3/(re-growth rate)

=$4.875/(0.12-0.04)

=$60.94

present value of price in year 2=$60.94*0.797=$48.57

current stock price=$7.09 +$48.57=$55.66

If taya's shares are trading at $10 it is trading cheap hence should be bought.

Dividend yield=$3.75/$55.66 =6.74%

Taya's capital gain yield=$55.66-