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Amador Corporation has a stock price of $24 a share. The stock's year-end dividend is expected to...

Question:

Amador Corporation has a stock price of $24 a share. The stock's year-end dividend is expected to be $2 a share. The stock's required rate of return is 12 percent and the stock's dividend is expected to grow at the same constant rate forever.

What is the expected price of the stock six years from now?

Expected Capital Gains Yield:

The expected capital gains yield is a part of the total return on a stock that is determined by the price appreciation of the stock. This contrasts with the dividend yield from the stock which is determined by dividend payments.

Answer and Explanation:

We first compute the dividend growth rate of the stock using the dividend growth model:

  • dividend growth rate = required return - next dividend / current price
  • dividend growth rate = 12% - 2 / 24
  • dividend growth rate = 3.67%

Since the price of the stock will grow at the same rate as dividend, and the current stock price is 24, the expected price in 6 years will be:

  • {eq}24*(1 + 3.67\%)^6 = 29.79 {/eq}

Learn more about this topic:

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The Dividend Growth Model

from Finance 101: Principles of Finance

Chapter 14 / Lesson 3
9.8K

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