Anderson Corp just issued a stock dividend of$2.00 yesterday. The company plans on increasing the dividend by 6% per year for the next 5 years. After which, the dividend will grow at 3% forever. The required rate of return is 10%.

A) Calculate the current price of the stock

B) Calculate what the price of the stock should be in 1 year

C) Calculate the Dividend yield and capital gains yield during the first year.

A). The current price of stock=$38.24

B). The price of the stock at year 1=$30.29

C). The dividend yield=7%

D). Capital gains yield=6%

Explanation:

A). Determine the current price of the stock using the formula;

Required rate of return = (expected dividend payment/current stock price) + expected dividend growth rate

where;

Expected dividend payments for years 1-5 is given by the formula;

dividend payment (1+dividend growth rate). Substituting;

year 1=2 (1+0.06) = 2.12

year 2=2.12 (1+0.06) = 2.2472

year 3=2.2472 (1+0.06) = 2.3820

year 4=2.3820 (1+0.06) = 2.5250

year 5=2.5250 (1+0.06) = 2.6765

Expected dividend payments after 5 years=2.6765

Current stock price=unknown=C

Expected dividend growth rate=3%=3/100=0.03

Required rate of return=10%=10/100=0.1

replacing;

0.1 = (2.6765/C) + 0.03

(2.6765/C) = 0.1-0.03=0.07

0.07 C=2.6765

C=2.6765/0.07=38.24

The current price of stock=$38.24

B). Price of the stock at 1 year

Using the expression above and substituting the following;

Expected dividend payments after 1 year=2.12

Current stock price=unknown=C

Expected dividend growth rate=3%=3/100=0.03

Required rate of return=10%=10/100=0.1

replacing;

0.1=2.12/C+0.03

2.12/C=0.1-0.03=0.07

0.07 C=2.12

C=2.12/0.07=30.29

The price of the stock at year 1=$30.29

C). The dividend yield is calculated as;

dividend yield=annual dividend/share price

where;

annual dividend=2.12

share price=30.29

replacing;

dividend yield=2.12/30.29=0.07=7%

The dividend yield=7%

D). The Capital gains yield is calculated as;

capital gains yield={ (Current price-original price) / original price}*100

Current price at year 1=$30.29

Original price=O

0.1=2/O+0.03

2/O=0.07

O=2/0.07=28.57

Original price=$28.57

Capital gains yield={ (30.29-28.57) / 28.57}*100=6%

Capital gains yield=6%