Question

Miltmar Corporation will pay a year-end dividend of $5, and dividends thereafter are expected to grow at the constant rate of 4% per year. The risk-free rate is 5%, and the expected return on the market portfolio is 12%. The stock has a beta of 0.72.
a. Calculate the market capitalization rate. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Market capitalization rate _____ %
b. What is the intrinsic value of the stock? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Intrinsic value ___ $.

Answer 1

Answer:

a. 10.04%

b. $82.78

Explanation:

In this question, we apply the Capital Asset Pricing Model (CAPM) formula which is shown below

a. Expected rate of return or market capitalization = Risk-free rate of return + Beta × (Market rate of return - Risk-free rate of return)

= 5% + 0.72 × (12% - 5%)

= 5% + 0.72 × 7%

= 5% + 5.04%

= 10.04%

The Market rate of return - Risk-free rate of return) is also known as the market risk premium and the same is applied.

b. Now the intrinsic value would be

= Expected dividend ÷ (Required rate of return - growth rate)  

= $5 ÷ (10.04% - 4%)

= $5 ÷ 6.04%

= $82.78