Kelsey Drums, Inc., is a well-established supplier of fine percussion instrument

Question

Kelsey Drums, 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 $5.00 per share per year
for the last 15 years. Management expects to continue to pay at that amount for
the foreseeable future. Sally Talbot purchased 100 shares of Kelsey class A common
10 years ago at a time when the required rate of return for the stock was 16%. She
wants to sell her shares today. The current required rate of return for the stock is
12%. How much capital gain or loss will Sally have on her shares?

Explanation / Answer

As dividend have not grown in last 10 years & will not increase in future, growth rate g=0 10 Yrs ago, Reqd return Ks = 16% & D=5.00 SO Stock Price P = D/Ks = 5/16% = $31.25.................(a) As growth g=0, the Stock price will remain same for 10 yrs. Now Reqt rate of return is 12%. Rest has not changed. So Current stopk price = P = 5/12% = $41.67 ...........(b) SO Capital gain on 100 Shares over 10 Yrs = 100*(b-a) = 100*( $41.67-31.25) = $1,042

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