Question

This morning you purchased a stock that just paid an annual dividend of $3.10 per share. You require a return of 9.2 percent and the dividend will increase at an annual growth rate of 4 percent. If you sell this stock in three years, what will your capital gain be? $5.87 $2.48 $7.74 $4.00 $10.13

Answer 1

Solution: 62.00 PO=D1/(r-g) 3.1*1.04/(0.092-0.04) D1 Dividend at the end of year 1 PO Price today P3 Price at the end of year 3 r required return g growth rate 64.48 P3=P1*(1+g) 62*(1+0.04) 2.48 capital gain=P3-P1 64.48-62

Answer 2

SOLUTION :

Current dividend, D0 = 3.10 ($)

Dividend growth rate, g = 4% = 0.04

Market rate of return, r = 9.2 % = 0.092

So, as per Dividend constant growth Discount Model :

Expected price currently, P0 

= D0(1+g) / (r - g) 

= 3.10(1 + 0.04) / (0.092 - 0.04)

= 62 ($).

Price expected after 3 years, P3 = 62(1 + 0.04)^3 = 69.74 ($)

So, capital gain, if stock is sold in 3 years 

= 69.74 - 62

= 7.74 ($) (ANSWER).