Assume that it is now January 1, 2006. Wayne-Martin Electric Inc. (WME) has just developed a solar panel capable of generating 200 percent more electricity than any solar panel currently on the market. As a result, WME is expected to experience a 15 percent annual growth rate for the next 5 years. By the end of 5 years, other firms will have developed comparable technology, and WME’s growth rate will slow to 5 percent per year indefinitely. Stockholders require a return of 12 percent on WME’s stock. The most recent annual dividend (D₀), which was paid yesterday, was $1.75 per share. 

a. Calculate WME’s expected dividends for 2006, 2007, 2008, 2009, and 2010.

b. Calculate the value of the stock today, P̂₀. Proceed by finding the present value of the dividends expected at the end of 2006, 2007, 2008, 2009, and 2010 plus the present value of the stock price that should exist at the end of 2010. The year-end 2010 stock price can be found by using the constant growth equation. Notice that to find the December 31, 2010, price, you must use the dividend expected in 2011, which is 5 percent greater than the 2010 dividend. 

c. Calculate the expected dividend yield, D₁/P₀, capital gains yield, and total return (dividend yield plus capital gains yield) expected for 2006. (Assume that P̂₀ = P₀, and recognize that the capital gains yield is equal to the total return minus the dividend yield.) Then calculate these same three yields for 2011.

d. How might an investor’s tax situation affect his or her decision to purchase stocks of companies in the early stages of their lives, when they are growing rapidly, versus stocks of older, more mature firms? When does WME’s stock become “mature” for purposes of this question?

e. Suppose your boss tells you she believes that WME’s annual growth rate will be only 12 percent during the next 5 years and that the firm’s long-run growth rate will be only 4 percent. Without doing any calculations, what general effect would these growth-rate changes have on the price of WME’s stock? 

f. Suppose your boss also tells you that she regards WME as being quite risky and that she believes the required rate of return should be 14 percent, not 12 percent. Without doing any calculations, how would the higher required rate of return affect the price of the stock, the capital gains yield, and the dividend yield? Again, assume that the long-run growth rate is 4 percent.