Question

Super Carpeting Inc. (SCI) just paid a dividend (D₀) of $2.40 per share, and its annual dividend is expected to grow at a constant rate (g) of 5.00% per year. If the required return (r s ) on SCI’s stock is 12.50%, then the intrinsic value of SCI’s shares is per share. Which of the following statements is true about the constant growth model? The constant growth model can be used if a stock’s expected constant growth rate is more than its required return. The constant growth model can be used if a stock’s expected constant growth rate is less than its required return. Use the constant growth model to calculate the appropriate values to complete the following statements about Super Carpeting Inc.: • If SCI’s stock is in equilibrium, the current expected dividend yield on the stock will be per share. • SCI’s expected stock price one year from today will be per share. • If SCI’s stock is in equilibrium, the current expected capital gains yield on SCI’s stock will be per share.

Answer 1

Answer:

Consider the following calculations.

Explanation:

1)

Intrinsic value = D1 / (Required rate - growth rate)

Intrinsic value = (2.4 * 1.05) / 0.125 - 0.05

Intrinsic value = 2.52 / 0.075

Intrinsic value = $33.60

2)

The constant growth model implies that dividends growth rate remains constant from now to infinity.

3)

Current dividend yield = (D1 / current stock price) * 100

Current dividend yield = (2.52 / 33.6) * 100

Current dividend yield = 7.50%

Stock price 1 year from today = Present value (1 + growth rate)

Stock price 1 year from today = 33.6 * (1 + 0.05)

Stock price 1 year from today = $35.28

Capital gains yield = [(Ending value - beginning value) / beginning value] * 100

Capital gains yield = [(35.28 - 33.6) / 33.6] * 100

Capital gains yield = 5.00%

Answer 2

1.  The intrinsic value of SCI’s shares is $33.6 per share.

2. The statement that is true is: The constant growth model can be used if a stock’s expected constant growth rate is less than its required return

3a. The current expected dividend yield on the stock is 7.50%.

3b. The Stock price in 1 year is $35.28 per share.

3c. The Expected Capital Gains Yield is 5.00%.

1)  Intrinsic Value is calculated using this formula

Intrinsic Value = [D0 × (1 + g)] / [r - g]

Let plug in the formula

Intrinsic Value = [$2.40 * (1 + 0.05)] / [0.125 - 0.05]

Intrinsic Value = $2.52/ 0.075

Intrinsic Value = $33.6

2) The statement that is true is:

The constant growth model can be used if a stock’s expected constant growth rate is less than its required return.

3-a) Expected Dividend Yield is calculated using this formula

Expected Dividend Yield= D1 / P0

Let plug in the formula

Expected Dividend Yield= $2.52 / $33.6

Expected Dividend Yield= 0.075 or 7.5%

3-b) Stock price in 1 year is calculated using this formula

Stock price= Price now ×(1 + g)

Let plug in the formula

Stock price= $33.6 × (1 + 0.05)

Stock price= $35.28

3-c) Expected Capital Gains Yield is calculated using this formula

Expected Capital Gains Yield= Required Return - Expected Dividend Yield

Let plug in the formula

Expected Capital Gains Yield= 12.50% - 7.5%

Expected Capital Gains Yield= 5.00%

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