Red, Inc., Yellow Corp., and Blue Company each will pay a dividend of $3.00 next year. The growth rate in dividends for all three companies is 6 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?

Red, Inc., Yellow Corp., and Blue Company each will pay a dividend of $3.00 next year. The growth rate in dividends for all three companies is 6 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? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

	Stock price
Red, Inc.	$
Yellow Corp.	$
Blue Company	$

 

Explanation:

We can use the constant dividend growth model, which is:

Pt = Dt × (1 + g) / (R – g)

So the price of each company’s stock today is:

Red stock price = $3.00 / (.08 − .06) = $150.00

Yellow stock price = $3.00 / (.11 − .06) = $60.00

Blue stock price = $3.00 / (.14 − .06) = $37.50

As the required return increases, the stock price decreases. This is a function of the time value of money: A higher discount rate decreases the present value of cash flows. It is also important to note that relatively small changes in the required return can have a dramatic impact on the stock price.