Top Technologies Corporation (TTC) has been growing at a rate of 20% per year in recent years. This same growth rate is expected to last for another 2 years. The company has just paid a dividend of $1.60 and the cost of equity is 10% and the normal growth rate after 2 years is equal to 6%.

Required:

a Calculate the expected dividends for the coming 3 years.

b What is the share price now? What is the share price one year later if the cost of equity remains at 10%?

c. What is the expected dividend yield and capital gains yield now?

d. What will be TTC‘s dividend yield and capital gains yield once its period of supernormal growth ends?

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**Technifi Expert’s Answer:**

**a) Calculate the expected dividends for the coming 3 years.**

Present Dividend D0 = 1.60

Dividend expected in next 3 years:

Year 1 = 1.60 + (20/100)*1.60 = 1.92

Year 2 = 1.92 + (20/100)*1.92 = 2.30

Year 3 = 2.304 + (6/100)*2.304 = 2.44

**b What is the share price now? What is the share price one year later if the cost of equity remains at 10%?**

We will first calculate the present values of the dividends during the high growth years 1 and 2.

PV = FV/(1+i)n

where,

PV is present value

FV is Future Value

i is cost of equity

n is year in which the dividend will be paid in the future.

Then,

PV of Dividend in 1st year = 1.92/(1+10/100)1 = 1.75

PV of Dividend in 2nd year = 2.30/(1+10/100)2 = 1.90

Now calculate the Terminal Value of the stock in year 2 (after the high growth period has ended) = Dividend in 3rd year (D1)/ (Cost of equity – Long Term Growth Rate)

= 2.44/ (10%-6%) = 61

Hence, PV of this terminal value = 61/(1+10%)2 = 50.41

The Stock Price today = PV of Dividend in 1st Year + PV of Dividend in 2nd Year + PV of Terminal Value of the Stock

The Stock Price today = 1.75+1.90+50.41

**Stock Price today = $54.06**

Share Price a Year Later:

PV of Dividend in Year 2 = 2.30/ (1+10%) = 2.09 (1 year later dividend in Year 2 is only 1 year away)

Now, calculate the Terminal Value of the stock in year 2 (after the high growth period has ended) = Dividend in 3rd year (D1)/ (Cost of equity – Long Term Growth Rate) = 2.44/ (10%-6%) = 61

The PV of this Terminal Value = 61/(1+10%) = 55.45

Hence,Stock price after 1 year = 2.09 + 55.45

**Stock price after 1 year = $57.54**

**c) What is the expected dividend yield and capital gains yield now?**

Expected Dividend Yield = Expected Annual Dividend D1/ Current Market Price

Expected Dividend Yield = (1.92/ 54.06)*100

**Expected Dividend Yield = 3.55%**

Expected Capital Gains Yield = Expected Return on the Stock or Cost of Equity – Expected Dividend Yield

Expected Capital Gains Yield = 10% – 3.55%

**Expected Capital Gains Yield = 6.45%**

**d. What will be TTC‘s dividend yield and capital gains yield once its period of supernormal growth ends?**

Dividend Yield = Annual Dividend / Market Price (after supernormal growth ends)

Dividend Yield = (2.30/ 61)*100

**Dividend Yield = 3.77%**

Capital Gains Yield = Expected Return on the Stock or Cost of Equity – Dividend Yield

Capital Gains Yield = 10% – 3.77%

**Capital Gains Yield = 6.23%**

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