a.

D1 = D0 (1 + g s) = $1.6(1.20) = $1.92.
D2 = D0 (1 + g s)2 = $1.60(1.20)2 = $2.304.
P2 = D3 /Ks g n
D3 = D2 (1 + g n)
= 2.304 (1.06) = 2.44224
P2 = 2.44224 / (0.10 0.06)
= $61.06
P0 = PV of D1 + PV of D2 + PV of P2
= D1/ (1 + 0.10) + D2/ (1 + 0.10)2 + P2/ (1 + 0.10)2
= 1.92/ (1 + 0.10) + 2.304/ (1 + 0.10)2 + 61.06/ (1 + 0.10)2
= $54.11
Part 2: Expected dividend yield:
D1/P0 = $1.92/$54.11 = 3.55%.
Capital gains yield: First, find P1 which equals the sum of the present values of D 2 and P2 discounted
for one year.
P1 = 2.303/ (1 + 0.10) + 61.06/ (1 + 0.10)
= $57.60
Second, find the capital gains yield:
= P1 P0
P0
= 57.60 54.11
54.11
= 6.45%
Dividend yield =
Capital gains yield =
k s=
b.

3.55%
6.45
10.00%.

Due to the longer period of supernormal growth, the value of the stock will be higher for each year.
Although the total return will remain the same, ks = 10%, the distribution between dividend yield and capital
gains yield will differ: The dividend yield will start off lower and the capital gains yield will start off higher
for the 5-year supernormal growth condition, relative to the 2-year supernormal growth state. The dividend
yield will increase and the capital gains yield will decline over the 5-year period.