Question

Red, Inc., Yellow Corp., and Blue Company each will pay a dividend of $3.65 next year. The growth rate in dividends for all three companies is 4 percent. The required return for each company’s stock is 8 percent, 11 percent, and 14 percent, respectively. What is the stock price for each company?

Answer 1

The value of each company's shares of stock

Red: $91.25

Yellow:$52.14

Blue: $36.50

Step 1

The constant dividend growth model, which is written as

Pt = Dt (1 + g)/(R - g)

Step2

Therefore, the current stock price for each company is:

Price of the red stock is $3.65/(0.08 -0.04) = $91.25.

Price of the yellow stock is $3.65/(0.11 -0.04) = $52.14.

Price of the blue stock is $3.65/(0.14 -0.04) = 36.50.

The stock price falls as the needed return rises. A greater discount rate reduces the present value of cash flows, which is a function of the time value of money. The stock price can be significantly affected by even slight changes in the needed return, which is another crucial point to remember.

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