This morning, you purchased a stock that will pay an annual dividend of $1.90 per share next...

Question:

This morning, you purchased a stock that will pay an annual dividend of $1.90 per share next year. You require a 12 percent rate of return and the annual dividend increases at 3.5 percent annually.

What will your capital gain be on this stock if you sell it three years from now?

Capital Gains Yield:

The capital gains yield on a stock is the rate of return the stock generates through price appreciation. This contrasts with the rate of return the stock generates through dividend payments, known as the dividend yield.

Answer and Explanation:

We can use the dividend growth model to answer this question, because the dividend grows at a constant rate. According to this model, the price of the stock will grow at same rate as the dividends. Therefore, the expected capital gains is the same as the dividend growth rate. That is, the price of the stock will be growing at the rate of 3.5% annually. Thus, the total capital gains after three years will be:

  • {eq}(1 + 3.5\%)^3 - 1 = 10.87\% {/eq}

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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