Given the following information, calculate the expected capital gains yield for Chicago Bears Inc.: beta = 0.6; rM = 15%; rRF = 8%; D1 = $2.00; P0 = $25.00. Assume the stock is in equilibrium and exhibits constant growth.
A) 3.8%
B) 0%
C) 8.0%
D) 4.2%
E) 2.5%

Question

Quizplus · Accepted Answer

Using the constant growth formula, we can determine the expected dividend yield and the expected capital gains yield, and then add them together to find the overall expected return:

D1 = $2.00 (given)
P0 = $25.00 (given)
g = ?

r = rRF + (beta x (rM - rRF)) = 8% + (0.6 x (15% - 8%)) = 12.2% (required return)

D0 = D1 / (1 + g) = D1 / (1 + r) = $2.00 / (1 + 0.122) = $1.78 (current dividend)

g = (P0 x g) / P0 = (D1 / P0) + g = ($2.00 / $25.00) + g = 0.08 + g

Solving for g:

0.08 + g = (1 - 0.6) x 12.2%
g = 0.042 or 4.2%

Therefore, the expected capital gains yield is 4.2%.

Given the Following Information, Calculate the Expected Capital Gains Yield