Question

Miltmar Corporation will pay a year-end dividend of $3, and dividends thereafter are expected to grow at a constant rate of 5% per year. The risk-free rate is 5%, and the expected return on the market portfolio is 10%. The stock has a beta of 0.85.
a. Calculate the market capitalization rate.
b. What is the intrinsic value of the stock?Market capitalization rate is another name for the stock's required rate of return. It is called the market capitalization rate because we can infer it by observing the market value of the stock. One way to find this rate is the capital asset pricing model (CAPM).

Answer 1

Part a: The market capitalization rate is 9.25%

Part b: The intrinsic value of the stock is $70.59

Market capitalization rate is another name for the stock's required rate of return. It is called the market capitalization rate because we can infer it by observing the market value of the stock. One way to find this rate is the capital asset pricing model (CAPM).

Part a:

Let,

r = market capitalization rate

f = risk free rate = 5%

m = return on the market = 10%

We can find the market capitalization rate with the help of the capital asset pricing model (CAPM),

$r=f+\beta *(m-f)\\ r=0.05+0.85*(0.1-0.05)\\ r=9.25\%$

The market capitalization rate is 9.25%.

Part b:

Let,

D be the dividend expected = $3

r be the interest rate = 9.25%

g = growth rate of dividends = 5%

The price is given by the dividend growth model:

$Price=\frac{D}{r-g}\\ Price=\frac{3}{0.0925-0.05}\\ Price=\ 70.59$

The intrinsic value of the stock is $70.59

Learn more about CAPM:

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