Common stock value under different market conditions (LO5) Ecology Labs, Inc., w

Question

Common stock value under different market conditions (LO5) Ecology Labs, Inc., will pay a dividend of $3 per share in the next 12 months (D1). The required rate of return (Ke) is 10 percent and the constant growth rate is 5 percent. a. Compute P0. (For parts b, c, d in this problem, all variables remain the same except the one specifically changed. Each question is independent of the others.) b. Assume Ke, the required rate of return, goes up to 12 percent; what will be the new value of P0? c. Assume the growth rate (g) goes up to 7 percent; what will be the new value of P0? Ke goes back to its original value of 10 percent. d. Assume D1 is $3.50; what will be the new value of P0? Assume Ke is at its original value of 10 percent and g goes back to its original value of 5 percent.

Explanation / Answer

a)P0= D1/(Ke-g) =3/(.10-.05)= $60 b) 3/(.12-.05)= $42.857 c) 3/(.10-.07)= $100 d) 3.5/(.1-.05)= $70

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