Question

Just before the outbreak of the Corona virus you bought a stock expected to pay a constant dividend (without growth) once every year for the foreseen future. Right after the outbreak you revalue the stock. Due to fact that the company will make zero profits this year, you expect that the dividend at the end of the year cannot be paid. However, you expect the previous dividend schedule to resume in 2 years from now. According to the Dividend Growth Model, how much did your stock lose in value (in percent) due to the corona virus outbreak? Assume that the required return for this stock is 5%.

Answer 1

Answer: 9.3%

Explanation:

If the company continues to payoff its dividend at current rate, then the price of stock will be:

= Dividend/Rate of return

= 1/5%

= 1/0.05

= 20

Now, when the company isn't expected to pay any dividends for the next two years, the price of stock at the end of year 2 will be:

= Dividend/Rate of return

= 1/5%

= 1/0.05

= 20

Price of stock today will be the present value of p2. This will be:

= 20/(1.05^2)

= 20/1.1025

= 18.14

Loss in value= (20-18.4)/20 × 100

= 1.86/20 × 100

= 9.3%