6. Wariable and/or Supernormal growth Rainbow Industries, Inc. just paid a divid
ID: 2814764 • Letter: 6
Question
6. Wariable and/or Supernormal growth Rainbow Industries, Inc. just paid a dividend of $3 per share of common stock. Analysts expect the company's dividend to grow 50% the next two years, and then settle into a constant growth rate of 10%. The required rate of return on the company's stock is 15% What should be the current price of the company's stock? Calculate a. D: 3054.50 D245 ( 6.75 = 2 D3- N' Calculate the following: Expected Dividend Yield at P0- Expected Capital Gains Yield at PO- b. 4.50 ng% RY 370 1.43 S- 0, PoExplanation / Answer
Answer a.
Recent Dividend, D0 = $3.00
Growth Rate for next 2 years is 50%, followed by a constant growth rate (g) of 10%
D1 = $3.00 * 1.50 = $4.50
D2 = $4.50 * 1.50 = $6.75
D3 = $6.75 * 1.10 = $7.43
Required Return, r = 15%
P2 = D3 / (r - g)
P2 = $7.43 / (0.15 - 0.10)
P2 = $148.60
P0 = $4.50/1.15 + $6.75/1.15^2 + $148.60/1.15^2
P0 = $121.38
Answer b.
Expected Dividend Yield = D1 / P0
Expected Dividend Yield = $4.50 / $121.38
Expected Dividend Yield = 3.71%
Expected Capital Gain Yield = Required Return - Expected Dividend Yield
Expected Capital Gain Yield = 15% - 3.71%
Expected Capital Gain Yield = 11.29%
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