Credenza Industries is expected to pay a dividend of $1.20 at the end of the coming year. It is expected to sell for $62.00 at the end of the year. If its equity cost of capital is 8%, what is the expected capital gain from the sale of this share at the end of the coming year?

Question

Quizplus · Accepted Answer

The expected capital gain can be calculated using the formula: (Expected Selling Price - Purchase Price) / Purchase Price.
Purchase price can be determined using the dividend discount model: 
Purchase Price = Dividend / (Cost of Capital - Dividend Growth Rate)
Since the dividend is only given for the coming year, we can assume that the dividend growth rate is 0%. 
Therefore, Purchase Price = $1.20 / (0.08 - 0) = $15.00
Expected capital gain = ($62 - $15) / $15 = $3.47 or $3.48 (rounded to the nearest cent)

Credenza Industries Is Expected to Pay a Dividend of $1