Thursday, 31 July 2014

Suppose you know that a company’s stock currently sells for $66.90 per share and the required return on the stock is 9 percent. You also know that the total return on the stock is evenly divided between capital gains yield and dividend yield.

Suppose you know that a company’s stock currently sells for $66.90 per share and the required return on the stock is 9 percent. You also know that the total return on the stock is evenly divided between capital gains yield and dividend yield.

Required:
If it’s the company’s policy to always maintain a constant growth rate in its dividends, what is the current dividend per share? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

  Dividend per share $  




Explanation:
We know the stock has a required return of 9 percent, and the dividend and capital gains yield are equal, so:

Dividend yield = 1/2(.09)
Dividend yield = .045 = Capital gains yield

Now we know both the dividend yield and capital gains yield. The dividend is simply the stock price times the dividend yield, so:

D1 = .045($66.90)
D1 = $3.01 

This is the dividend next year. The question asks for the dividend this year. Using the relationship between the dividend this year and the dividend next year:

D1 = D0(1 + g)

We can solve for the dividend that was just paid:

$3.01 = D0(1 + .045)
D0 = $3.01 / 1.045
D0 = $2.88