Given the following information, calculate the expected capital gains yield for Chicago Bears Inc.: beta = 0.6; rM = 15%; rRF = 8%; = $2.00; P0 = $25.00.Assume the stock is in equilibrium and exhibits constant growth.

Question

Quizplus · Accepted Answer

First, we need to calculate the cost of equity using the capital asset pricing model (CAPM):

Re = rRF + beta*(rM - rRF)
Re = 8% + 0.6*(15% - 8%)
Re = 12.2%

Next, we can use the constant growth formula to calculate the expected capital gains yield:

g = (P1 - P0) / P0 = Div1 / P0 - Re, where Div1 is the expected dividend one year from now, and P1 is the expected stock price one year from now.

Since the problem tells us that the stock exhibits constant growth, we can use the Gordon growth model to calculate Div1:

Div1 = D0 * (1 + g)
Div1 = $2.00 * (1 + g)

We can rearrange the formula for g to solve for the unknown:

g = Div1 / P0 - Re
g = [$2.00 * (1 + g)] / $25.00 - 12.2%
g = 8.8% * (1 + g) - 12.2%
g = 8.8% + 8.8%g - 12.2%
g = -3.4% / 8.8%
g = -0.386

This negative value means that we expect the stock price to decrease, so the correct answer is:
Choice: D (4.2%)

Given the Following Information, Calculate the Expected Capital Gains Yield