5. Expected returns, dividends, and growth

The constant growth valuation formula has dividends in the numerator. Dividends are divided by the difference between the required return and dividend growth rate as follows:

P0P0

= =

D1(rs gL)D1rs gL

Which of the following statements best describes how a change in a firms stock price would affect a stocks capital gains yield?

The capital gains yield on a stock that the investor already owns has an inverse relationship with the firms expected future stock price.

The capital gains yield on a stock that the investor already owns has a direct relationship with the firms expected future stock price.

Walter Utilities is a dividend-paying company and is expected to pay an annual dividend of $2.85 at the end of the year. Its dividend is expected to grow at a constant rate of 7.50% per year. If Walters stock currently trades for $23.00 per share, what is the expected rate of return?

8.55%

19.89%

7.62%

15.39%

Walters dividend is expected to grow at a constant growth rate of 7.50% per year. What do you expect to happen to Walters expected dividend yield in the future?

It will decrease.

It will increase.

It will stay the same.