Question

You have the following data regarding a share of stock in a particular firm:

The dividend at the end of the current year is expected to be $4.93/share
The dividend is expected to grow at a constant rate forever
The dividend growth rate is -4.53%
Investors in the stock expect a 20.77% total return from investing in the stock
What will be the capital gains yield for the second year (t=1 to t=2)?

Answer 1

The capital gains yield for the second year is equal to the total expected return of 20.77%, as the dividend yield will also be -4.53% assuming constant stock prices.

Step-by-step explanation:

The capital gains yield for the second year when the dividend is expected to decline at a constant rate is equal to the total expected return minus the dividend yield for that year. Given that the total expected return is 20.77% and the dividend is set to decline by 4.53%, the dividend yield for the second year can be computed using the first year's dividend adjusted for the growth rate, leading to a dividend yield of -4.53% in the second year, assuming the stock price at the start and end of the year remains the same.

Hence, considering the total expected return stays constant, the capital gains yield for the second year would also be 20.77% since the negative growth in dividends suggests the yield is all from capital gains.