Question

Red, Inc., Yellow Corp., and Blue Company each will pay a dividend of $3.25 next year. The growth rate in dividends for all three companies is 5 percent. The required return for each company's stock is 8.60 percent, 11.70 percent, and 14.40 percent, respectively. Required: (a) What is the stock price for Red. Inc., Company? (Click to select) (b) What is the stock price for Yellow Corp. Company? (Click to select) (c) What is the stock price for Blue Company? (Click to select)

Answer 1

Answer :-

1- a) $90.278

   b) $48.507

   c) $ 34.574

2- Option A - $39.28

.

Explanations :-

1)

before we start the calculations, let's recall the Gordan growth dividend discount model for calculating the share price. This model says:

Where, P = Price per share

D₁ = Expected dividend next year = $ 3.25

K_e = Cost of equity or required return by the shareholder

g = perpetual growth rate = 5%

a)

For Red Inc., K_e = 8.60%; Hence, P =$ 3.25 / (8.60% - 5%)

= $3.25 / 0.036 = $90.278

b)

For Yellow Corp., K_e = 11.70%; Hence, P = 3.25 / (11.70% - 5%)

= $3.25 / 0.067 = $48.507

c)

For Blue Company, K_e = 14.40%; Hence, P = 3.25 / (14.40% - 5%)

= $3.25 / 0.094 =$ 34.574

.

2)

the price of the stock in Year 7 will be:

Price of stock on 10 th year = next year dividend / (Required rate of return - Growth rate )

P₁₀= D₁₁ / (R – g)

P₁₀= $8 / (.13 – .07)

P₁₀= $8 / 0.06

P₁₀= $133.33

The price of the stock today is simply the PV of the stock price in the future. We simply discount the future stock price at the required return. The price of the stock today will be:

P₀ = $133.33 / 1.13¹⁰

P₀ = $133.33/ 3.39456

price of the stock today = 39.28