# Case 78 Essay

1211 Words5 Pages
Questions 1. According to ValueLine estimates in Figure 1, James River’s expected annual dividend growth rate from the 91–93 to 97–99 period is 5.50%, and the next dividend (1995) is expected to be \$0.60. Assume that the required return for James River was 8.36% on January 1 1995 and that the 5.50% growth rate was expected to continue indefinitely. a. Based on the Constant Growth Rate or Gordon Model, what was James River’s price at the beginning of 1995? 20.98 b. What conditions must hold to use the constant growth model? Do many “real world” stocks satisfy the constant growth assumptions? The dividends and growth rate will remain constant over time. No, In the real world earnings will differ from year to year 2. The Wall Street Journal (WSJ) lists the current price of James River common stock at \$27.00. a. Based on this information, the ValueLine 1995 expected dividend, and the annual rate of dividend change for the growth estimate, what is the company’s return on common stock using the constant growth model? What is the expected dividend yield and expected capital gains yield? Explain the difference in the required return estimates from the ValueLine (see question 1a) to the WSJ price data. Expected Return= 7.72% Expected Dividend Yield = D1/P0 = .60/27=2.22% Capital Gains Yield = g = 5.5% The dividend remained constant at .\$60 and the stock price went up causing the return to go down. b. What is the relationship between dividend yield and capital gains yield over time under constant growth assumptions? They both remain constant 3. A successful joint venture is expected to result in the 4.0% growth rate until 2000 but would increase the company’s normal growth rate to a constant 8.00% after that time. The joint venture also is expected to increase investors’ required return to