Question
A corporation has just paid a dividend of $5.00, i.e. D o =$5.00. Due to its growth potential, its dividends are expected to grow at
A corporation has just paid a dividend of $5.00, i.e. Do=$5.00. Due to its growth potential, its dividends are expected to grow at 5% per year starting with the next dividend.
a) If you require 15% of return from your investments in stock of companies similar to this one, what would be the maximum price that you are willing to pay?
b) If today's market price of the stock is at the level that you calculated in part a, what is the dividend yield of this stock?
c) In a year, suppose you still require 15% of return from your investments in stock of companies similar to this one. What would be the maximum price that you are willing to pay to buy the stock then? [Hint: The stock's dividends increase over time]
d) Suppose today's market price of the stock is at the level that you calculated in part a and market price of the stock a year later is at the level calculated in part c. If an investor purchases the stock today and sell it exactly a year later, what is the rate of return on this investment? How much of this return comes from the dividend and how much from capital gains (in %)?
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