Consider an investment with the initial purchase price of 11

Consider an investment with the initial purchase price of $11 and dividend and terminal price as follows. The terminal price means the stock price at the end of forecast year (in this question, year 2). Determine the average annual dividend yield.

Year 0 1 2

Cashflow buy price $11 Dividend = $2 Dividend =$2 / Terminal price = $14

A. higher than 5% but less than 7%

B. less than 3%

C. higher than 7%

Solution

Answer is

C. higher than 7%

Workings:

Calculation of annual dividend yield for Year 0:

Annual dividend yield = Annual dividend/current stock price

Since annual dividend for Year 0 is nil, the annual dividend yield is also zero.

Calculation of annual dividend yield for Year 1:

Annual dividend yield = Annual dividend/current stock price

= $2/$11*100

= 18.18%

Calculation of annual dividend yield for Year 2:

Annual dividend yield = Annual dividend/current stock price*100

= $2/$14*100

= 14.29%

Average annual dividend yield = (0+18.18+14.29)/3

= 10.82%