Expected Dividend Yield
As companies evolve, certain factors can drive sudden growth. This may lead to a period of nonconstant, or variable, growth. This would cause the expected growth rate to increase or decrease, thereby affecting the valuation model. For companies in such situations, you would refer to the variable, or nonconstant, growth model for the valuation of the company?s stock.
Consider the case of Portman Industries:
Portman Industries just paid a dividend of $1.20 per share. The company expects the coming year to be very profitable, and its annual dividend is expected to grow by 16.00% over the next year. After the next year, however, Portman?s dividend is expected to grow at a constant rate of 3.20% per year.
Assume that market conditions are such that the risk-free rate is 4.00%, the market risk premium is 4.80%, and Portman?s beta is 2.00.
Given this information, the expected dividend yield for Portman?s stock today is:
- O 10.11%
- O 10.74%
- O 11.49%
- O 10.44
Equity Valuation refers to the process of finding the intrinsic value of a stock. There are many models available to calculate the value of a stock- like dividend valuation model, residual value etc. In dividend valuation model, the value of an equity stock is equal to the sum total of present value of all the future dividends to be received from the stock.
Answer and Explanation:
Required rate of return = risk free rate + beta * stock premium
Required return = 4% + 2 * 4.8%
Required return = 13.6%
dividend for next year = $1.2 * (1+1.16) = $1.39
Price of stock = Present value of all future dividends
Price = Present value of dividend for next year + present value of terminal value of stock
Price = $1.39 / (1 + 0.136) + $1.39 * (1+.032) / (0.136 - 0.032)
Price = $1.22 + $1.43 / 0.104
Price = $14.97
Expected dividend yield = Dividend for next year / price
Expected dividend yield = $1.39 / $14.97
Expected dividend yield = 10.11% (approx)
Learn more about this topic:
from Corporate Finance: Help & ReviewChapter 2 / Lesson 10