Problem: ABC Corp is expected to pay a dividend next year of 1.75 per share. Yearly profits for ABC Corp are expected to grow at a rate of 15% for the following 2 years (after next year) and then at 2% per year indefinitely. Because the company has stated that it will maintain its current dividend policy, dividends are expected to grow at the same rate as profits. The required rate of return is 14%.
Q1) Mr. Smith is considering buying shares of the company. Draw a time line of his investment and note all relevant cash flows for at least 4 years.
Q2) What is the value of a share of X Corp right now? In 1 year from now? In two years from now?
Q3) Calculate capital gains and dividend yields for the first two years. Can you draw any conclusion from this result.