Stock's Expected Return Calculation
What is the expected return for the stock?
Matthew has one share of stock and one bond. The total value of the two securities is $1,070.00. The bond has a YTM of 12.71 percent, a coupon rate of 8.22 percent, and a face value of $1,000.00; pays semi-annual coupons with the next one expected in 6 months, and matures in 4 years. The stock pays annual dividends that are expected to grow by 4.39 percent per year forever. The next dividend is expected to be $12.19 and paid in one year.
Expected Return Calculation:
The expected return for the stock is 9.87%.
An investor's anticipated or predicted rate of return from owning a stock is referred to as the stock's expected return. It is an estimate based on numerous criteria, such as past performance, market circumstances, company fundamentals, etc.
To find the expected return for the stock, we need to first calculate the value of the bond.
Using the bond's YTM and coupon rate, we can find the semi-annual coupon payment:
Coupon payment = Coupon rate x Face value / 2
Coupon payment = 8.22% x $1,000 / 2
Coupon payment = $41.10
We can then use the bond's YTM to calculate its present value:
Present value of bond = Coupon payment / (1 + YTM/2)^n + Face value / (1 + YTM/2)^n
n = number of semi-annual periods = 8 (4 years x 2 semi-annual periods per year)
Present value of bond = $41.10 / (1 + 0.1271/2)^8 + $1,000 / (1 + 0.1271/2)^8
Present value of bond = $847.44
Now we can find the value of the stock:
Value of stock = Total value of securities - Value of the bond
Value of stock = $1,070.00 - $847.44
Value of stock = $222.56
To find the expected return for the stock, we can use the dividend discount model:
Expected return = Dividend yield + Expected dividend growth rate
Dividend yield = Next dividend / Value of stock
Dividend yield = $12.19 / $222.56
Dividend yield = 0.0548 or 5.48%
Expected dividend growth rate = 4.39%
Expected return = 5.48% + 4.39%
Expected return = 9.87%
Therefore, the expected return for the stock is 9.87%.