Question

2. Starkey Percussion, Inc., is a well-established supplier of fine percussion instruments to orchestras all over the United States. The company’s class A common stock has paid a dividend of $7.25 per share per year for the last 12 years. Management expects to continue to pay at that amount for the foreseeable future. Paul Harrison purchased 1,000 shares of Starkey class A common 10 years ago at a time when the required rate of return for the stock was 13%. He wants to sell his share today. The current required rate of return for the stock is 11%. How much capital gain or loss will Paul have on his shares?

Answer 1

Required rate of return = (expected dividend payment/current stock price) + dividend growth rate

Expected dividend payment = $7.25 as the company expects to continue to pay in foreseeable future

Let's say the stock price 10 years ago was X

Dividend growth rate is 0% as there is no change in dividend payments, required rate of return 10 years back was 13%

Substituting the above values in the formula specified we get the equation as

13%= 7.25/X +0

13%=7.25/X

X=7.25/13%

X=55.76 was the stock price 10 years ago

Now, let's say the current stock price is Y

Dividend growth rate is 0 and required rate of return is 11%

Substituting the values in the given formula we get,

11%=7.25/Y +0

Y= 7.25/11%

Y=65.90 is the current stock price

Clearly, the current stock price is greater than the stock price 10 years ago, so it is a capital gain

Capital gain on 1 share= 65.90-55.76= 10.14

Capital gain on 1000 shares = 10.14* 1000 = 10,140