Professional Documents
Culture Documents
Chapter 5
Application
The first term on the right side of the equation is the stocks dividend yield,
which is the expected annual dividend of the stock divided by its current price.
The dividend yield is the percentage return the investor expects to earn from
the dividend paid by the stock.
The second term on the right side of the equation reflects the
capital gain the investor will earn on the stock, which is the
difference between the expected sale price and purchase price
for the stock, P1 P0. We divide the capital gain by the current
stock price to express the capital gain as a percentage return,
called the capital gain rate.
The sum of the dividend yield and the capital gain rate is called
the total return of the stock.
The total return is the expected return that the investor will earn
for a one-year investment in the stock.
Setting the stock price equal to the present value of the future cash flows in this
case implies:
A multiyear investor
Substituting this expression for P1 into Eq. 1, we get the same result as
in Eq. 3:
For the special case in which the firm eventually pays dividends
and is never acquired, it is possible to hold the shares forever.
Consequently, we can let N go to infinity in Eq. 4 and write it as
follows:
That is, the price of the stock is equal to the present value of the expected
future dividends it will pay.
Exercise
An investor bought a share of stock for 4.5 lei in January 2008.
The share of stock offered dividends in amount of 0.25 lei in
2008, 0.28lei in 2009, 0.25lei in 2010 and 0.3 lei in 2011. In
November 2011 he sold the share for 4.6 lei.
What was the real profitability from holding the share during this
period?