Question

Ecology Labs, Inc., will pay a dividend of $3.55 per share in the next 12 months (D₁). The required rate of return (Kₑ) is 20 percent and the constant growth rate is 10 percent. (Each question is independent of the others.)

(a) Compute the price of Ecology Labs' common stock. (Round your intermediate and final answer to 2 decimal places. Omit the "$" sign in your response.)
Price$
(b) Assume Kₑ, the required rate of return, goes up to 22 percent; what will be the new price? (Round your intermediate and final answer to 2 decimal places. Omit the "$" sign in your response.)
New price$
(c) Assume the growth rate (g) goes up to 14 percent; what will be the new price? Kₑ goes back to its original value of 20 percent. (Round your intermediate and final answer to 2 decimal places. Omit the "$" sign in your response.)
New price$
(d) Assume D₁ is $4.20; what will be the new price? Assume Ke is at its original value of 20 percent and g goes back to its original value of 10 percent. (Round your intermediate and final answer to 2 decimal places. Omit the "$" sign in your response.)

Answer 1

The price of Ecology Labs, Inc.'s common stock can be determined using the Gordon Growth Model by substituting the given values of dividends, required return, and growth rate. Different scenarios lead to different stock prices: $35.50 initially, then $29.58 with an increased Kᴇ, $59.17 with an increased growth rate, and $42.00 with an increased dividend.

Step-by-step explanation:

The price of Ecology Labs, Inc.'s common stock can be calculated using the Gordon Growth Model (also known as the Dividend Discount Model), which is given by the formula P = D₁ / (Kᴇ - g), where P is the price, D₁ is the expected dividend in the next 12 months, Kᴇ is the required rate of return, and g is the constant growth rate.For (a), substituting the given values we have P = $3.55 / (0.20 - 0.10) = $35.50.

For (b), if the required rate of return increases to 22%, the new price would be New Price = $3.55 / (0.22 - 0.10) = $29.58.

For (c), if the growth rate increases to 14% (and Kᴇ returns to 20%), the new price would be New Price = $3.55 / (0.20 - 0.14) = $59.17.For (d), if D₁ is $4.20 and both Kᴇ and g go back to their original values of 20% and 10% respectively, the new price would be New Price = $4.20 / (0.20 - 0.10) = $42.00.