Question

Question 2 (14 marks) Gamma Corp. is expected to pay the following dividends over the next four years: $5, $12, $18, and $1.80. Afterward, the company pledges to maintain a constant 4 percent growth rate in dividends, forever. If the required return on the stock is estimated to be 14 percent. (a) What is the share price at year 4? (2 marks) (b) What is the share price today? (3 marks) (c) If the stock is selling at $20 at year 4, i. What is the market required return at year 4? (3 marks) ii. What is the dividend yield at year 4? (1 mark) iii. What is the capital gain yield at year 4? (1 mark) (d) In general, the common stock holders of a corporation enjoy certain rights. Describe any TWO of such rights. (4 marks)

Answer 1

a. Share price at year 4

Since there is constant growth after year 4 , we can use gorden's formula for calculating share price at year 4

D_{​​​​​​4= Dividend at the end of year 4}=$1.80

K_{​​​​​​e=}Required return on common stock=14%

g=Constant Growth rate=4%

P_{​​​​​4=Share price at end of Year 4}

ke-g. (formula) (Constant Grown model) hehure cash inflows to stockholder = $37.92 Gamma Corp. Share price year P4= D41149 $1.80 (1 + 0.042 14). 47. Py = $18.72 Share Price at ant of 4 4 = $18.72 b. Share Price today Since, dividend paid over next four years are not constant or there is ho constant growth icre cannot dire Constant Groath Modd to find out We will use, PV of future Cash flows as: Year Cash flows & Doch 0.8772 12 0.7695 9.234 18 6.6750 1.9 0.5921 18.72 0.5921 share price today Present Values 4,386 1 5 2 3 4 12.150 1:066 11.084 Pripo= 37.92 Share prou today Present value of

c) Il stock is selling at $20 at year 4 & Market required return at year 4. Since there is constant growth after yo4 we will use Cordents formula to And out Market required return te ke P4 DuLi4g) ke og 20 = 1.80 C1H004) ke-4% ke 4% 0.0936 ke – 9.36%44% ke = 13.36%. Thursday . So, if stock is selling ad 420, marked 4 will be 13:36% years (1. Dividend yield at year 4, Dindend yield Dividend per share sequired return at Market priceps X100 $1.80 $20 Xloo
Dividend yield =

Dividend at year 4/current market price of share at year 4*100

Capital gain yield is calculated by assuming share is purchased at Theoretical fiat value of share which is computed in point b. I.e at $37.92