The Starr Co. just paid a dividend of $1.25 per share on its stock. The dividends are expected to grow at a constant rate of 5 percent per year indefinitely. Investors require a return of 12 percent on the company’s stock.What is the current stock price? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).) Current price$ What will the stock price be in three years? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).) Stock price$ What will the stock price be in 8 years? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).) Stock price$

Introduction:

Investors are always seeking to maximize their returns on investments, especially in the stock market. One way to achieve this is by investing in stocks that pay regular dividends and have the potential for future price appreciation. In this scenario, we will be looking at the case of Starr Co., a company that recently paid a dividend of $1.25 per share on its stock.

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Description:

Starr Co.’s dividends are expected to grow at a constant rate of 5 percent per year indefinitely. However, investors require a return of 12 percent on the company’s stock. The question we will be exploring is what the current stock price of Starr Co. is, given that information. We will also be determining the stock price of Starr Co. in 3 years and 8 years, based on the same assumptions. Through this analysis, we will gain insight into the growth and potential of Starr Co. as an investment opportunity.

Current Stock Price:

To calculate the current stock price, we need to use the dividend discount model. The formula for this is as follows:

Current Stock Price (P0) = Dividend / (Required Rate of Return – Dividend Growth Rate)

Substituting the given values, we get:

P0 = $1.25 / (0.12 – 0.05) = $20.83

Therefore, the current stock price of Starr Co. is $20.83.

Stock Price in Three Years:

To calculate the stock price in three years, we can use the formula for future stock price, which is:

Stock Price in X Years (PX) = Dividend X+1 / (Required Rate of Return – Dividend Growth Rate)

Substituting the given values, we get:

P3 = $1.25 * (1 + 0.05)3 / (0.12 – 0.05) = $25.31

Therefore, the stock price of Starr Co. in three years is $25.31.

Stock Price in Eight Years:

Similarly, to calculate the stock price in eight years, we can use the same formula:

P8 = $1.25 * (1 + 0.05)8 / (0.12 – 0.05) = $36.62

Therefore, the stock price of Starr Co. in eight years is $36.62.

Objectives:

– To understand how to calculate the current stock price using dividend growth rate

– To learn how to calculate the future stock price after a period of time based on constant dividend growth rate

– To understand how to determine whether an investment in a stock is profitable based on the required rate of return of investors

Learning Outcomes:

By the end of this activity, participants will able to:

– Calculate the current stock price of a company using the dividend growth rate formula

– Calculate the future stock price of a company after a specific period of time based on constant dividend growth rate

– Determine whether a stock is profitable for investors based on the required rate of return

Headings:

– Objectives

– Learning Outcomes

Solution 1:

To determine the current stock price of Starr Co., we need to use the dividend discount model. The formula for the dividend discount model is as follows:

Current Stock Price = Dividend / (Required Rate of Return – Dividend Growth Rate)

Using the data given, we can calculate the current stock price as follows:

Current Stock Price = $1.25 / (0.12 – 0.05) = $20.83

Therefore, the current stock price is $20.83.

Solution 2:

To determine the stock price in three years and eight years, we can use the same formula as above, but we need to make adjustments for the dividend growth rate.

Stock Price in Three Years = Dividend * (1 + Dividend Growth Rate)^3 / (Required Rate of Return – Dividend Growth Rate)

Stock Price in Eight Years = Dividend * (1 + Dividend Growth Rate)^8 / (Required Rate of Return – Dividend Growth Rate)

Using the data given, we can calculate the stock price in three years as follows:

Stock Price in Three Years = $1.25 * (1 + 0.05)^3 / (0.12 – 0.05) = $18.01

Therefore, the stock price in three years is $18.01.

Using the same formula, we can calculate the stock price in eight years as follows:

Stock Price in Eight Years = $1.25 * (1 + 0.05)^8 / (0.12 – 0.05) = $27.68

Therefore, the stock price in eight years is $27.68.

Suggested Resources/Books:

1. “Fundamentals of Corporate Finance” by Richard A. Brealey, Stewart C. Myers, and Alan J. Marcus

2. “Valuation: Measuring and Managing the Value of Companies” by McKinsey & Company Inc.

3. “Investments: An Introduction” by Herbert B. Mayo

Similar Asked Questions:

1. How are dividends calculated and what factors affect dividend growth rate?

2. What is the significance of a company’s required rate of return for investors?

3. What are some methods used for stock valuation in finance?

4. How does inflation affect the stock price of a company?

5. What are the limitations of using constant growth models in stock valuation?

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