Risk-free rate = 6%

market risk premium = 5%

beta = 1.5

Per CAPM: E(r) = RFR + ?(Rmkt - RFR), where Rmkt - RFR = the market risk premium

E(r) = 6 + 1.5(5%) = 13.5%

a) P0......Next, calculate all your dividends:

Do = $1.50/share (dividend just paid)

gsn1 = 15% (first 2 years) >D1 =1.50*1.15 = 1.725, D2 = 1.725*1.15 = 1.98375

gsn2 = 8% (next 4 years) >D3 = 1.98375 * 1.08 = 2.14245 and so on, D4=2.31385, D5 = 2.49895, D6 = 2.69887

gc = 5% (constant, starting at the end of year 6) D7 = 2.69887 * 1.05 = 2.83381

Per Gordon Growth model: P6 = D7 / (r - g)

P6 = 2.83381 / (0.135 - 0.05) = $33.33898, round to $33.34

round the dividends to two decimal places (if this is the way you've been taught), e.g. D1 = $1.73

P0 = D1/1.135 + D2/1.135^2 +...+ D6/1.135^6 + P6 / 1.135^6
the "+...+" means fill in the missing discounted dividends

b) for this question, you need to calculate P1, which will be the sum of the discounted cash flows starting with D2/1.135 + D3/1.135^2 +...+D6/1.135^5 + P6/1.135^5

because from the perspective of the end of year one, the price will be the sum of the future cash flows from THAT time point, e.g in one year from that time you'll receive D2, etc.

then...

dividend yield = D1 / P1..the dividend you received in year 1 / the price at the end of year 1

capital gain yield: (P1 / P0) - 1

theses two figures will be in decimal form, multiply by 100 to get % form

FYI: for part "b", if this were a simple constant growth situation (e.g. no super-normal growth first), the dividend yield would be (r - g)

and the capital gain yield would be: g

here's why: say you have D0 = $1, r = 0.10 and g = 0.04, so D1 = 1.04

P0 = D1 / (r-g) = 1.04 / 0.06 = 17.33

dividend yield: 1.04 /17.33 = 0.06 <(r - g)

year 2...P1 = 1.04(1.04) / (0.10 - 0.04) = 18.03

capital gain yield: (P1 / P0) - 1 = (18.03 / 17.33) - 1 = 0.04, or 4%
Given:

Risk-free rate = 6%

market risk premium = 5%

beta = 1.5

Do = $1.50/share (dividend just paid)

gsn1 = 15% (first 2 years)

gsn2 = 8% (next 4 years)

gc = 5% (constant, starting at the end of year 6)

Problem:

a. Determine the maximum price (Po) an informed buyer would pay for this stoc, assuming all the information provided is correct

b. Determine the expected dividend yield and the expected capital gains yield for year one