1Heliocorpular Magnetics is currently valued at 32 per share. They are expected

Question

1Heliocorpular Magnetics is currently valued at 32 per share. They are expected to pay a 3.20 dividend, because the dividend has been growing at 5% per year for the past 8 years.Find the dividend yield, the capital gains yield and the expected return for this stock

2Timco has paid 2.50 per share to the preferred shareholders each year for the past 20 years. We believe this will continue forever. Timco has a beta of 1.6, the risk free rate is 2% and the market is expected to earn 11%. What would be a fair price for the Timco stock?

Explanation / Answer

1. Dividend Yield = Cash Dividend per share / Market Price per share

=3.2/32 = 10%

Dividend next year = 3.2*(1+5%) = $ 3.36

Using Dividend discount model,

Price = Dividend next year/(Rate of return - Growth rate)

32 = 3.36/(r-5%)

r - 5% = 10.5%

Rate of return (r) = 10.5%+5% = 15.5%

Stock price last year = 3.2/(15.5%-5%) = $ 30.48

Capital Gains = 32-30.48/30.48 = 5%

2. Dividend per year = $ 2.50

Cost of equity = Risk Free Rate + Beta*(Market return - risk free rate)

=2% + 1.6*(11%-2%) = 16.40%

Based on perpetuity model,

Price = Dividend/Rate of return

=2.5/16.40% = $ 15.244

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