BUS 415: INVESTMENT AND PORTFOLIO MANAGEMENT
SPRING 2011, AUBG
Quiz 5(a)
Problem 1 (10 points)
The Duo Growth company just paid a dividend of $1 per share. The dividend is
expected to grow at a rate of 25% per year for the next two years
and then to level
off to 5% per year forever
. You think the appropriate market capitalization rate is
20% per year.
a.
What is your estimate of the intrinsic value of a share of the stock?
b.
If the market price of a share is equal to this intrinsic value what is the expected
dividend yield?
c.
What do you expect its price to be in one year from now? Is the implied capital
gain consistent with your estimate of the dividend yield and the market
capitalization rate? (Note: Capital gain = (P
1
– P
0
)/P
0
)
Solution:
Time:
0
1
2
3
D
t
$1.0000
$1.2500
$1.5625
$1.640625
g
25.0%
25.0%
25.0%
5.0%
a.
The dividend to be paid at the end of year 3 is the first installment of a dividend stream
that will increase indefinitely at the constant growth rate of 5%. Therefore, we can use
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 Spring '11
 john
 Dividends, Dividend, Dividend yield, P/E ratio

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