A B C D E F G H

1 2/1/2012
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3 Chapter 5. Solution for Ch 5-20 Build a Model
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7 Rework Problem 5-19. Conroy Consulting Corporation (CCC) has been growing at a rate of 30% per year in
8 recent years. This same growth rate is expected to last for another 2 years (g 1 = g2 = 20%).
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10 a. If D0 = $2.50, rs = 12%, and gn = 7%, what is CCC's stock worth today? What are its expected dividend
11 yield and capital gains yield at this time?
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13 1. Find the price today.
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15 D0 $2.50
16 rs 12.0%
17 g0,1 30% Short-run g; for Year 1 only.
18 g1,2 30% Short-run g; for Year 2 only.
19 gL 7% Long-run g; for Year 3 and all following years.
20 30% 7%
21 Year 0 1 2 3
22 Dividend $2.50 3.25 4.225 4.52075
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24 PV of dividends
25 $2.9018
26 3.3681 4.52075 = D2x(1+g) = D
27 $72.0783 90.4150 = Horizon value = P2 =
28 5.0% = rs g L
29 $78.3482 = P0
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32 2. Find the expected dividend yield.
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34 Recall that the expected dividend yield is equal to the next expected annual dividend divided by the price at the
35 beginning of the period.
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37 Dividend yield = D1 / P0
38 Dividend yield = $3.250 / $78.348
39 Dividend yield = 4.15%
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42 3. Find the expected capital gains yield.
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45 The capital gains yield can be calculated by simply subtracting the dividend yield from the total expected return.
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47 Cap. Gain yield= Expected return Dividend yield
48 Cap. Gain yield= 12.0% 4.15%
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49 Cap. Gain yield= 7.85%
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51 Alternatively, we can recognize that the capital gains yield measures capital appreciation, hence solve for the price in
52 one year, then divide the change in price from today to one year from now by the current price. To find the price one
53 year from now, we will have to find the present values of the terminal value and second year dividend to time period
54 one.
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56 P2 + D2
P1 =
57 (1 + rs)
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59 $90.415 + $4.225
P1 =
60 1.12
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62 P1 = $84.50
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64 Cap. Gain yield= (P1 P0) / P0
65 Cap. Gain yield= $6.15 / $78.3482
66 Cap. Gain yield= 7.85%
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69 b. Now assume that CCC's period of nonconstant growth is to last for 5 years rather than 2 years. How
70 would this affect its price, dividend yield, and capital gains yield?
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72 1. Find the price today.
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74 D0 $2.50
75 rs 12.0%
76 gS 30% Short-run g; for Years 1-5 only.
77 gL 7% Long-run g; for Year 6 and all following years.
78 30% 7%
79 Year 0 1 2 3 4 5 6
80 Dividend $2.50 3.25 4.225 5.4925 7.14025 9.282325 9.93208775
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82 PV of dividends
83 $2.9018
84 3.3681
85 3.9095
86 4.5378
87 5.2670
88 9.9321
89 $112.7147 Horizon value = P5 = 198.6418 =
90 $132.6988 = P0 5.0%
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93 Part 2. Finding the expected dividend yield.
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95 Dividend yield = D1 / P0
96 Dividend yield = $3.250 / $132.699
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97 Dividend yield = 2.45%
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100 Part 3. Finding the expected capital gains yield.
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102 Cap. Gain yield= Expected return Dividend yield
103 Cap. Gain yield= 12.0% 2.45%
104 Cap. Gain yield= 9.55%
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c. What will CCC's dividend yield and capital gains yield be once its period of nonconstant growth ends?
107 (Hint: These values will be the same regardless of whether you examine the case of 2 or 5 years of
nonconstant growth, and the calculations are very easy.)

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109 We used the 5-year nonconstant growth scenario for this calculation, but ultimately it does not matter which example
110 you use, as they both yield the same result.
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112 Dividend yield = Dn+1 / Pn
113 Dividend yield = $9.9321 / $198.6418
114 Dividend yield = 5.0%
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116 Cap. Gain yield= Expected return Dividend yield
117 Cap. Gain yield= 12.0% 5.0%
118 Cap. Gain yield= 7.0%
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120 Upon reflection, we see that these calculations were unnecessary because the constant growth assumption holds that
121 the long-term growth rate is the dividend growth rate and the capital gains yield, hence we could have simply
122 subtracted the long-run growth rate from the required return to find the dividend yield.
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= D2x(1+g)
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88 = D5x(1+g) = D6
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