Tattletale News Corp has been growing at a rate of 10 per ye

Tattletale News Corp. has been growing at a rate of 10% per year, and you expect this growth rate in earnings and dividends to continue for another 3 years. The last dividend paid was $3. The discount rate is 19% and the steady growth rate after 3 years is 4%. o. What is the capital gain in stock price from year O to year 1? (Do not round intermediate caiculations. Enter your answer as a dollar amount rounded to 3 decimal places.) b. Calculate the expected rate of return. (Do not ound intermediate celculations. Round your answer to the nearest whole percent.) ed rate of

Solution

(a) Three Year Growth Rate = 10 % per annum

Last Dividend = D0 = $ 3

Therefore, D1 = 3 x 1.1 = $ 3.3, D2 = 3.3 x 1.1 = $ 3.63 and D3 = 3.63 x 1.1 = $ 3.993

D4 = 3.993 x 1.04 = $ 4.15272

Discount Rate = 19 %

Terminal Value of Dividends at the end of Year 3 = 4.15272 / (0.19 - 0.04) = $ 27.6848

Stock Price at the end of Year 0 = 3.3 / 1.19 + 3.63 / (1.19)^(2) + 3.993 / (1.19)^(3) + 27.6848 / (1.19)^(3) = $ 24.1346

Stock Price at the end of year 1 = 3.63 / 1.19 + 3.993 / (1.19)^(2) + 27.6848 / (1.19)^(2) = $ 25.4202

Capital Gains between year 1 and year 2 = (25.4202 - 24.1346) = $ 1.2856 or $ 1.286 approximately.

(b) Expected Rate of Return from Year 0 to Year 1 = K = (D1 / P0) + Prevailing growth rate = (3.3/24.1346) + 0.1 = 0.2367 or 24 % approximately.