Given the following information, calculate the expected capital gains yield for Bimlo Bottle...

Question:

Given the following information, calculate the expected capital gains yield for Bimlo Bottle Caps:

beta=0.6

km=15%

Rf=8%

D1=$2.00

P0=$25.00

Assume the stock is a constant growth stock and is in equilibrium.

Gordon Growth Model:

The Gordon growth model is one of the most widely used equity valuation model. The model is also used to ascertain the cost of equity capital for the given firm on the basis of the trading price.

Answer and Explanation:


The capital gains yield is likely to be 2.20%


The Gordon growth model can be represented as:

{eq}Price = \dfrac{D_{1}}{r-g} {/eq}

Here:

  • D1 is dividend = $2.00
  • r is the CAPM return = 8% + 0.6(15% - 8%) = 10.20%
  • g is to be calculated
  • Price or P0 = $25.00

Using the aforementioned values into the formula we have:

{eq}$25.00 = \dfrac{ $ 2.00 }{0.1020-g}\\ {0.1020-g} = \dfrac{ $ 2.00}{ $ 25.00}\\ g = 0.022 {/eq}

The capital gains yield equals the growth in dividends. Therefore, the capital gains yield shall be 2.20%.


Learn more about this topic:

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The Dividend Growth Model

from Finance 101: Principles of Finance

Chapter 14 / Lesson 3
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