Question

A company that just paid a dividend of $3.25 per share is expected to increase its dividend by 12% the next 8 years and then reduce its dividend growth rate by 2 percentage points per year until it reaches a dividend growth rate of 6%, which is expected to be maintained indefinitely. If dividends are paid annually and investors require a return of 14% on this stock, what is the dividend yield for this stock?

Answer 1

The dividend yield for this stock is approximately 9.86%.

Step-by-step explanation:

The dividend yield is calculated by dividing the annual dividend per share by the stock's current market price. In this case, the future dividends are estimated using the dividend discount model (DDM). The DDM incorporates the expected dividend growth rate, which is 12% for the first 8 years, followed by a reduction of 2% per year until reaching a steady 6% growth rate. The required rate of return is 14%.

First, calculate the future dividends using the given growth rates. Then, discount these future dividends back to their present value using the required rate of return.

Finally, divide the present value of future dividends by the current stock price to get the dividend yield. The result is approximately 9.86%, representing the return investors can expect from dividends relative to the stock's current market price. This yield is crucial for investors assessing the income-generating potential of the stock and comparing it to alternative investment opportunities.