35. Determine the capital gains yield and the dividend yield of a stock.

Capital gains yield – the capital gain during a given year divided by the beginning price.

The price appreciation component of a security's (such as a common stock) total return. For stock holdings, the capital gains yield will be the change in price divided by the original (purchase) price.

Calculated as: capital gains yield= P – P / P

Where: P₀ = market price of the stock today

P₁ = expected price of the stock at the end of each year

Dividend yield of a stock – the expected dividend divided by the current price of a share of stock. A financial ratio that shows how much a company pays out in dividends each year relative to its share price. D /P

36. Define the two parts of most stock’s expected total return.

Total return accounts for two categories of return: expected dividend yield and expected capital gain yield. Total return includes interest, capital gains, dividends and distributions realized over a given period of time. Calculated as:

ETR=EDY+ECGY

37. Write out and explain the valuation formula for a constant growth stock.

Used to find the value of a constant growth stock. Growth stock – shares in a company whose earnings are expected to grow at an above-average rate relative to the market.

- dividend

− growth rate

required rate of return

- first dividend expected

this is a necessary condition for equation. If the required rate of return is not greater than growth rate, the results will be both wrong and meaningless.

38. Define the conditions that a company must hold if a stock to be evaluated using the constant growth model.

For a constant growth stock, the following conditions must hold:

1. The dividend is expected to grow forever at a constant rate, g.

2. The stock price is expected to grow at this time.

3. The expected dividend yield is a constant.

4. The expected capital gains yield is also a constant, and it equal to growth rate, g.

5. The expected total rate of return, , is equal to the expected dividend yield plus the expected growth rate: = dividend yield + g.

39. Explain how one would find the value of a supernormal growth stock.

supernormal growth or nonconstant growth the part of the firm’s cycle in which it grows rapidly than the economy as a whole.

Many firms enjoy periods of rapid growth. These periods may result from the introduction of a new product, a new technology, or an innovative marketing strategy. However, the period of rapid growth cannot continue indefinitely. Eventually, competitors will enter the market and catch up with the firm. This section presents a more general approach which allows for the dividends/growth rates during the period of rapid growth to be forecast. Then, it assumes that dividends will grow from that point on at a constant rate which reflects the long-term growth rate in the economy. Stocks, which are experiencing the above pattern of growth, are called nonconstant, supernormal, or erratic growth stocks. The value of a nonconstant growth stock can be determined using the following equation:

- stock value

N – years of supernormal growth

D – dividend

- stockholder’s required rate of return

- growth rate

How to find out stock’s value:

1. Find the PV of the dividends during the period of nonconstant growth.

2. Find the price of the stock at the end of the nonconstant growth period,

at which point it has become a constant growth stock, and discount this

price back to the present.

3. Add these two components to find the intrinsic value of the stock, .