Question

Taussig Technologies Corporation (TTC) has been growing at a rate of 15% per year in recent years. This same growth rate is expected to last for another 2 years, then decline to On = 5%. a. If Do = $1.00 and is = 13%, what is TTC's stock worth today? Do not round intermediate calculations. Round your answer to the nearest cent. What is its expected dividend yield at this time, that is, during Year 17 Do not round intermediate calculations. Round your answer to two decimal places. What is its capital gains yields at this time, that is, during Year 1? Do not round intermediate calculations. Round your answer to two decimal places. b. Now assume that TTC's period of supernormal growth is to last for 5 years rather than 2 years. How would this affect the price, dividend yield, and capital gains yield? 1. Due to the longer period of supernormal growth, the value of the stock will be higher for each year. The total return as well as the distribution between dividend yield and capital gains yield with differ for the duration of the supernormal growth period. II. Due to the longer period of supernormal growth, the value of the stock will be higher for each year. The total return as well as the distribution between dividend yield and capital gains yield will remain the same for the duration of the supernormal growth period. III. Due to the longer period of supernormal growth, the value of the stock will be lower for each year. The total return as well as the distribution between dividend yield and capital gains yield wil differ for the duration of the supernormal growth period. IV. Due to the longer period of supernormal growth, the value of the stock will be higher for each year. Although the total return will remain the same, the distribution between dividend yield and capital gains yield will differ for the duration of the supernormal growth period. V. Due to the longer period of supernormal growth, the value of the stock will be lower for each year. Although the total return will remain the same, the distribution between dividend yield and capital gains yield will differ for the duration of the supernormal growth period. c. What will TTC's dividend and capital gains yields be once its period of supernormal growth ends? (Hint: These values will be the same regardless of whether you examine the case of 2 or 5 years of supernormal growth the calculations are very easy.) Round your answers to two decimal places. Dividend yield: Capital gains yield:

Answer 1

Ans. a)

Given

Dividend (D ₀) = $ 1.0

Non Constant Growth Rate (i) = 15% or 0.15

Constant Growth Rate (g) = 5% or 0.05

Required rate of return (r_s) = 13% or 0.13

Calculate value of D ₁ and D ₂

D ₁ = D ₀ (1+i)

= $ 1.0 ( 1 + 0.15) = $ 1.0 ( 1.15) = $ 1.15

D ₂ = D ₁ ( 1 + i)

= $ 1.15 ( 1 + 0.15) = $ 1.15 (1.15) = $ 1.3225

Now we calculate P ₂

P ₂ = D ₂ (1+g) / r_s - g

= $ 1.3225 ( 1+ 0.05) / 0.13 - 0.05

= $ 1.3225 (1.05) / 0.08

= $ 1.3886 / 0.08 = $ 17.358

Now Price of stock today is calculated as

P ₀ = D ₁ / (1+r)¹ + D ₂ / (1+r)² + P ₂ / (1+r)²

P ₀ = $ 1.15  / (1+ 0.13)¹ + $ 1.3225 / (1+ 0.13)² + $ 17.358/ (1+0.13)²

P ₀ = $ 1.15  / (1.13)¹ + $ 1.3225 / (1.13)² + $ 17.358/ (1.13)²

P ₀ = $ 1.017699 + $ 1.0357115 + $ 13.59386 = $ 15.6473

Now Dividend Yield is calculated as

Dividend Yield = D ₁ / P ₀ = $ 1.15 / $ 15.6473 = 7.3495%

Capital Gain Yield (g) =

r_s = D ₁ / P ₀ + g

13% = 7.3495% + g

g = 13% - 7.3495 % = 5.6505 %

Ans b)

Due to longer period of supernormal growth, the value of the stock will be higher for each year. Although the total return will remain the same, r_s=13%, the distribution between dividend yield and capital gains yield will differ:

The dividend yield will increase until dividend yield = 8% and the capital gains yield will decline until capital gain yield = 5% over the 5-year period and the return remains same = 8% + 5% = 13% .

So the correct ans is IV.

Ans c)

Once the period of supernormal growth ends the Capital Gain Yield will be 5% and Dividend Yield will be 8% as the total return remain same as 13%.

These are calculated without any calculations because the total return will remain same as 13% and the company will have constant growth on its future cash flows as 5% i.e Capital Gain Yield . So the remaining is the Dividend Yield i.e 13% - 5% = 8%.

Ans d)

Some investors need cash dividends (generally those who are retired ) while others would prefer growth. Also, investors must pay taxes each year on the dividends received during the year, while taxes on capital gains can be delayed until the gain is actually realized.

So the correct ans is I.