Question

Red, Inc., Yellow Corp., and Blue Company each will pay a dividend of $2.50 next year. The growth rate in dividends for all three companies is 6 percent. The required return for each company's stock is 8.20 percent, 12.10 percent, and 15.70 percent, respectively.

What is the stock price for Red. Inc., Company?

What is the stock price for Yellow Corp. Company?

What is the stock price for Blue Company?

Answer 1

We will use the formula - Price of stock = D1 / (Re - g)

Where D1 is the dividend for year 1

Re is required rate of return

g is growth rate

Note - In the question it states that the companies will pay dividend $2.50 next year . This is D1.

D1 = $2.50

g = 6% or 0.06

Calculation of Price of Stock for Red Inc

Re = 8.20% or 0.082

Price of stock = D1 / (Re - g)

= $2.50 / (0.082 – 0.06)

= $2.50 / 0.022

= $113.64

The Price of stock = $113.64

Calculation of Price of Stock for Yellow Corp

Re = 12.10% or 0.121

Price of stock = D1 / (Re - g)

= $2.50 / (0.121 – 0.06)

= $2.50 / 0.061

= $40.98

The Price of stock = $40.98

Calculation of Price of Stock for Blue Company

Re = 15.70% or 0.157

Price of stock = D1 / (Re - g)

= $2.50 / (0.157 – 0.06)

= $2.50 / 0.097

= $25.77

The Price of stock = $25.77