Problem 9-21 Nonconstant growth

Assume that it is now January 1, 2016. Wayne-Martin Electric Inc. (WME) has just developed a solar panel capable of generating 200% more electricity than any other solar panel currently on the market. As a result, WME is expected to experience a 15% annual growth rate for the next 5 years. Other firms will have developed comparable technology at the end of 5 years, and WME's growth rate will slow to 5% per year indefinitely. Stockholders require a return of 12% on WME's stock. The most recent annual dividend (D0), which was paid yesterday, was $1.75 per share.

Calculate WME's expected dividends for 2016, 2017, 2018, 2019 and 2020. Round your answers to the nearest cent. D2015 = $ D2016 = $ D2017 = $ D2018 = $ D2019 = $

Calculate the value of the stock today, . Proceed by finding the present value of the dividends expected at the end of 2015, 2016, 2017, 2018 and 2019 plus the present value of the stock price that should exist at the end of 2019. The year-end 2019 stock price can be found by using the constant growth equation. Notice that to find the December 31, 2019, price, you must use the dividend expected in 2020, which is 5% greater than the 2019 dividend. Round your answer to the nearest cent. $

Calculate the expected dividend yield (D1/P0), capital gains yield, and total return (dividend yield plus capital gains yield) expected for 2015. (Assume that and recognize that the capital gains yield is equal to the total return minus the dividend yield.) Round your answers to two decimal places. D1/P0 = % Capital gains yield = % Expected total return = % Then calculate these same three yields for 2020. Round your answers to two decimal places. D6/P5 = % Capital gains yield = % Expected total return = %

How might an investor's tax situation affect his or her decision to purchase stocks of companies in the early stages of their lives, when they are growing rapidly, versus stocks of older, more mature firms? When does WME's stock become "mature" for purposes of this question?

a. Some investors need cash dividends, while others would prefer growth. Investors must pay taxes each year on the dividends received during the year, while taxes on the capital gain can be delayed until the gain is actually realized. The firm's stock is "mature" at the end of 2020.

b. Some investors need cash dividends, while others would prefer growth. Investors must pay taxes each year on the capital gain during the year, while taxes on the dividends can be delayed until the stock is sold. The firm's stock is "mature" at the end of 2020.

c. It is of no interest to investors whether they receive dividend income or capital gains income, since both types of income are always taxed at the same rate. The firm's stock is "mature" at the end of 2020.

d. It is of no interest to investors whether they receive dividend income or capital gains income, since taxes on both types of income must be paid in the current year. The firm's stock is "mature" at the end of 2020.

e. It is of no interest to investors whether they receive dividend income or capital gains income, since taxes on both types of income can be delayed until the stock is sold. The firm's stock is "mature" at the end of 2020.

Suppose your boss tells you she believes that WME's annual growth rate will be only 12% during the next 5 years and that the firm's long run growth rate will be only 4%. Without doing any calculations, what general effect would these growth-rate changes have on the price of WME's stock?

a. Since the firm's supernormal and normal growth rates are lower, the dividends and, hence, the present value of the stock price will be lower. The total return from the stock will remain the same, but the dividend yield will be larger and the capital gains yield will be smaller than they were with the original growth rates.

b. Since the firm's supernormal and normal growth rates are lower, the dividends and, hence, the present value of the stock price will be lower. The total return from the stock will remain the same, but the dividend yield will be smaller and the capital gains yield will be larger than they were with the original growth rates.

c. Since the firm's supernormal and normal growth rates are lower, the dividends and, hence, the present value of the stock price will be lower. The total return from the stock will decline, and both the dividend yield and the capital gains yield will be smaller than they were with the original growth rates.

d. Since the firm's supernormal and normal growth rates are lower, the dividends and, hence, the present value of the stock price will be lower. The total return from the stock will increase, and both the dividend yield and the capital gains yield will be greater than they were with the original growth rates.

e. Since the firm's supernormal and normal growth rates are lower, the dividends and, hence, the present value of the stock price will be lower. The total return from the stock will decline, and the dividend yield and the capital gains yield will be the same.

Suppose your boss also tells you that she regards WME as being quite risky and that she believes the required rate of return should be 14%, not 12%. Without doing any calculations, determine how the higher required rate of return would affect the price of the stock, the capital gains yield, and the dividend yield? Again, assume that the long-run growth rate is 4%.

a. As the required return increases, the price of the stock goes up, and both the capital gains and dividend yields increase initially.

b. As the required return increases, the price of the stock goes up, and both the capital gains and dividend yields decrease initially.

c. As the required return increases, the price of the stock remains the same since both the capital gains and dividend yields remain constant.

d. As the required return increases, the price of the stock goes down, but both the capital gains and dividend yields increase initially.

e. As the required return increases, the price of the stock goes down, but both the capital gains and dividend yields decrease initially.