3. Forecasting stock value Understanding the returns from investing When buying stock, you can expect to earn money through future current income (from ) and future capital appreciation (from ). Together, your total earnings from a given investment can be expressed in terms of the approximate yield. This value makes it easier for you to compare investment options. Understanding the Approximate Yield Equation The formula for the approximate yield of an investment can look intimidating, but it’s really just a function of three things: (1) average current income, (2) average capital gains, and (3) the average value of the investment. Based on the information in the table, compute each of these values for the two stocks over a 3-year period and enter the values into the bottom half of the table. Stock 1 Stock 2 Expected average annual dividends (2012–2014) $0.95 $2.65 Current stock price $50 $119 Expected future stock price (2014) $62 $149 Average current income (CI) $ $ Average capital gains (CG) $ $ Average value of the investment (VI) $ $ Next, derive the correct formula for approximate yield by correctly arranging these three variables in the equation that follows. Approximate YieldApproximate Yield = = / /

Fundamentals of Financial Management (MindTap Course List)

14th Edition

ISBN:9781285867977

Author:Eugene F. Brigham, Joel F. Houston

Publisher:Eugene F. Brigham, Joel F. Houston

Chapter8: Risk And Rates Of Return

Section: Chapter Questions

Problem 7TCL

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3. Forecasting stock value

Understanding the returns from investing

When buying stock, you can expect to earn money through future current income (from ) and future capital appreciation (from ). Together, your total earnings from a given investment can be expressed in terms of the approximate yield. This value makes it easier for you to compare investment options.

Understanding the Approximate Yield Equation

The formula for the approximate yield of an investment can look intimidating, but it’s really just a function of three things: (1) average current income, (2) average capital gains, and (3) the average value of the investment. Based on the information in the table, compute each of these values for the two stocks over a 3-year period and enter the values into the bottom half of the table.

	Stock 1	Stock 2
Expected average annual dividends (2012–2014)	$0.95	$2.65
Current stock price	$50	$119
Expected future stock price (2014)	$62	$149
Average current income (CI)	$	$
Average capital gains (CG)	$	$
Average value of the investment (VI)	$	$

Next, derive the correct formula for approximate yield by correctly arranging these three variables in the equation that follows.

Approximate YieldApproximate Yield

= =

/ /

Using this formula, you can see that the approximate yield for Stock 1 is and the approximate yield for Stock 2 is .

True or False: If both investments carry the same rate of risk, Stock 2 is a better investment than Stock 1.

True

False

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