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 is calculated by subtracting the current price from the expected future price. However, to find the current price, we use the dividend discount model for a one-year period: $P_0 = \frac{D_1 + P_1}{1 + r}$, where $P_0$ is the current price, $D_1$ is the dividend at the end of the year ($1.20), $P_1$ is the future price ($62.00), and $r$ is the equity cost of capital (8% or 0.08). Rearranging to solve for $P_0$, we get $P_0 = \frac{1.20 + 62.00}{1 + 0.08} = \frac{63.20}{1.08} = 58.52$. The capital gain is the difference between the future price and the current price, so $62.00 - $58.52 = $3.48.

Credenza Industries Is Expected to Pay a Dividend of $1