59533341-FM11-Ch-07-Instructors-Manual-1

# Thus the expected value one year from now is 3210 p1

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Unformatted text preview: o on. Thus, the expected value one year from now is \$32.10: Ö P1 = Mini Case: 7 - 18 2 ( rs  g ) = \$2.247 \$2.247 = = \$32.10. (0.13  0.06) 0.07 d. 4. What are the expected dividend yield, the capital gains yield, and the total return during the first year? Answer: The expected dividend yield in any year n is Dividend Yield = Dn , Ö P n1 While the expected capital gains yield is Capital Gains Yield = ( Ö n  Ö n 1 ) =rÖ n 1 n . n 1 Thus, the dividend yield in the first year is 10 percent, while the capital gains yield is 6 percent: Total return = 13.0% ividend yield = \$2.12/\$30.29 = 7.0% Capital gains yield = 6.0% e. Now assume that the stock is currently selling at \$30.29. What is the expected rate of return on the stock? Answer: The constant growth model can be rearranged to this form:  r s= 1 g. 0 Here the current price of the stock is known, and we solve for the expected return. For Temp Force:  r s= \$2.12/\$30.29 + 0.060 = 0.070 + 0.060 = 13%. Mini Case: 7 - 19 f. What would the stock price be if its dividends were expected to have zero growth? Answer: If Temp Force¶s dividends were not expected to grow at all, then its dividend stream would be a perpetuity. Perpetuities are valued as shown below: 0 r = 13% s g = 0% | 1 2 3 | | | 2.00 2.00 2.00 1.77 1.57 1.39 . . . P0 = 15.38 P0 = PMT/r = \$2.00/0.13 = \$15.38. Note that if a preferred stock is a perpetuity, it may be valued with this formula. Mini Case: 7 - 20 g. Now assume that Temp Force is expected to experience supernormal growth of 30 percent for the next 3 years, then to return to its long-run constant growth rate of 6 percent. What is the stock¶s value under these conditions? What is its expected dividend yield and capital gains yield be in year 1? In year 4? Answer: Temp Force is no longer a constant growth stock, so the constant growth model is not applicable. Note, however, that the stock is expected to become a constant growth stock in 3 years. Thus, it has a nonconstant growth period followed by constant growth. The easie...
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