Suppose an investor knows that a company's stock currently sells for $47 per share and the required return on the stock is 11%. He also knows that the total return on the stock is evenly divided between a capital gains yield and a dividend yield.
If it's the company's policy to always maintain a constant growth rate in its dividends, what is the current dividend per share?
The return on a stock is composed of the returns from the dividends paid by the company and the returns as a result of the change in the price of the stock. The return from the change in price can be negative too.
Answer and Explanation:
The current dividend per share is $2.45
Let's calculate the total dollar return from the stock:
Total Dollar Return = $47 * 11% = $5.17
Now half of this is return from dividend i.e.
=$5.17 / 2 = $2.59
In calculating the stock price from the dividend growth model, the next period dividend is used. Hence for the current dividend, it should be discounted back one period at the growth rate. The growth rate is the capital gains yield which is half of 11%.
=11% / 2 = 5.5%
Hence the current dividend per share is:
$2.59 / (1 + 5.5%)
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from Corporate Finance: Help & ReviewChapter 2 / Lesson 10