Question

stock valuation and required return (lo2) 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%. the required return for each company's stock is 8%, 11%, and 14%, respectively. what is the stock price for each company? what do you conclude about the relationship between the required return and stock price?

Answer 1

To calculate the stock price for each company, you can use the Gordon Growth Model. The stock price for Red, Inc. is $91.25, for Yellow Corp. is $52.14, and for Blue Company is $40.18. The relationship between the required return and stock price is that as the required return increases, the stock price decreases.

Step-by-step explanation:

To calculate the stock price for each company, we can use the Gordon Growth Model. The formula for the Gordon Growth Model is:

Stock Price = Dividend / (Required Return - Growth Rate)

Using this formula, we can calculate the stock price for each company:

• For Red, Inc.: Stock Price = $3.65 / (0.08 - 0.04) = $91.25
• For Yellow Corp.: Stock Price = $3.65 / (0.11 - 0.04) = $52.14
• For Blue Company: Stock Price = $3.65 / (0.14 - 0.04) = $40.18

Based on the calculations, the stock price for Red, Inc. is $91.25, for Yellow Corp. is $52.14, and for Blue Company is $40.18. As for the relationship between the required return and stock price, we can observe that as the required return increases, the stock price decreases. This is because investors will be willing to pay less for a stock that provides a lower rate of return.