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?
$2.43 $2.51 $2.63 $2.87 $2.92

Answer 1

Answer:

The correct answer is $2.43.

Explanation:

The annual dividend is $1.90.

The expected rate of return is 12%.

The growth rate is 3.5%.

The current stock price will be

=$\frac{dividend}{required rate of return-growth rate}$

=$\frac{1.90}{12-3.5}$

=$\frac{1.90}{0.085}$

=$22.35

The stock price at year 3 will be

=$\frac{dividend*(1-growth rate)^3}{required rate of return-growth rate}$

=$\frac{1.90*(1+0.035)^3}{12-3.5}$

=$\frac{1.90*1.10}{0.085}$

=$24.78

The capital gain will be

=stock price at year 3-current stock price

=$24.78-$22.35

=$2.43