Hamilton Landscaping's dividend growth rate is expected to be 30% in the next year, drop to 15% from Year 1 to Year 2, and drop to a constant 5% for Year 2 and all subsequent years. Hamilton has just paid a dividend of $2.50 and its stock has a required return of 11%.

a. What is Hamilton's estimated stock price today?

D₀

$2.50

r_s

11.0%

g_0,1

30%

Short-run g; for Year 1 only.

g_1,2

15%

Short-run g; for Year 2 only.

g_L

5%

Long-run g; for Year 3 and all following years.

g

30%

15%

5%

5%

Year

0

1

2

3

Dividend

PV of dividends and PV of horizon value

= D₂ (1+g) = D₃

= Horizon value = P₂ =

= r_s g_L

= P₀

a. What is Hamilton's estimated stock price for Year 1?

P₁

=

P₂

+

D₂

(1 + r_s)

P₁

=

+

P₁

=

b. If you bought the stock at Year 0, what your expected dividend yield and capital gains for the upcoming year?

1. Find the expected dividend yield.

Dividend yield =

D₁

/

P₀

Dividend yield =

/

Dividend yield =

2. Find the expected capital gains yield.

Use the estimated price for Year 1, P₁, to find the expected gain.

Cap. Gain yield=

(P₁ P₀)

/

P₀

Cap. Gain yield=

/

Cap. Gain yield=

Alternatively, the capital gains yield can be calculated by simply subtracting the dividend yield from the total expected return.

Cap. Gain yield=

Expected return

Dividend yield

Cap. Gain yield=

Cap. Gain yield=

c. What your expected dividend yield and capital gains for the second year (from Year 1 to Year 2)? Why aren't these the same as for the first year?

1. Find the expected dividend yield.

Dividend yield =

D₂

/

P₁

Dividend yield =

/

Dividend yield =

2. Find the expected capital gains yield.

Use the estimated price for Year 2, P₂, to find the expected gain.

Cap. Gain yield=

(P₂ P₁)

/

P₁

Cap. Gain yield=

/

Cap. Gain yield=

Alternatively, the capital gains yield can be calculated by simply subtracting the dividend yield from the total expected return.

Cap. Gain yield=

Expected return

Dividend yield

Cap. Gain yield=

Cap. Gain yield=