Question

Credenza Industries is expected to pay a dividend of $1.05 at the end of the coming year. It is expected to sell for $63 at the end of the year. If its equity cost of capital is 9%, what is the expected capital gain from the sale of this stock at the end of the coming year? O A $4.24 OB. $5.20 OC. $58.76 OD. $57.80

Answer 1

Price of the stock at the end of the year P1 = $63

Expected dividend next year D1 = $1.05

The equity cost of capital re = 9%

Dividend growth rate g =?

We can calculate dividend growth rate with the help of following formula

P1 = D1 *(1+g)/ (re-g)

$63 = $1.05 * (1+g)/ (9% -g)

Or g = 7.213%

Expected capital gain from the sale of the stock at the end of year = Price of the stock at the end of the year - Price of the stock at the beginning of the year = (P1 – P0)

Where,

Price of the stock at the beginning of the year P0 = D1/ (re –g)

Or P1 = $1.05 / (9% -7.213%)

Or P1 = $58.76

Therefore,

Expected capital gain from the sale of the stock at the end of year = $63 - $58.76 = $4.24

Therefore correct answer is option A. $4.24