Top Dividend Stocks

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19. Capital Gains versus Income Consider four different stocks, all of which have a required return of 20 percent and a most recent dividend of $4.50 per share. Stocks W, X, and Y are expected to maintain constant growth rates in dividends for the foreseeable future of 10 percent, 0 percent, and -5 percent per year, respectively. Stock Z is a growth stock that will increase its dividend by 20 percent for the next two years and then maintain a constant 12 percent growth rate, thereafter. What is the dividend yield for each of these four stocks? What is the expected capital gains yield? Discuss the relationship among the various returns that you find for each of these stocks.

20. Stock Valuation Most corporations pay quarterly dividends on their common stock rather than annual dividends. Barring any unusual circumstances during the year, the board raises, lowers, or maintains the current dividend once a year and then pays this dividend out in equal quarterly installments to its shareholders.

a. Suppose a company currently pays a $2.50 annual dividend on its common stock in a single annual installment, and management plans on raising this dividend by 8 percent per year, indefinitely. If the required return on this stock is 14 percent, what is the current share price?

b. Now suppose that the company in (a) actually pays its annual dividend in equal quarterly installments; thus, this company has just paid a $.625 dividend per share, as it has for the previous three quarters. What is your value for the current share price now? (Hint: Find the equivalent annual end-of-year dividend for each year.) Comment on whether or not you think that this model of stock valuation is appropriate.

21. Nonconstant Growth Warf Co. just paid a dividend of $4.00 per share. The company will increase its dividend by 20 percent next year and will then reduce its dividend growth rate by 5 percentage points per year until it reaches the industry average of 5 percent, after which the company will keep a constant growth rate, forever. If the required return on Warf stock is 13 percent, what will a share of stock sell for today?

22. Nonconstant Growth This one's a little harder. Suppose the current share price for the firm in the previous problem is $104.05 and all the dividend information remains the same. What required return must investors be demanding on Warf stock? (Hint: Set up the valuation formula with all the relevant cash flows, and use trial and error to find the unknown rate of return.)

Intermediate

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Challenge

(Questions 19-22)

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