Question

National Advertising just paid a dividend of D 0 = $0.75 per share, and that dividend is expected to grow at a constant rate of 6.50% per year in the future. The company's beta is 1.25, the required return on the market is 10.50%, and the risk-free rate is 4.50%. What is the company's current stock price?

Answer 1

Answer:

$14.52

Explanation:

The calculations proceed as follows:

Step 1: Calculation of expected return

This is done by using the Capital Asset Pricing Model (CAPM) formula as follows:

ERi = Rf + βi(ERm - Rf) ........................................... (1)

Where:

ERi = expected return of investment = ?

Rf = risk-free rate  = 4.50% = 0.0450

ERm = market rate = 10.50% = 0.1050

βi  = beta of the investment  = 1.25

(ERm  - Rf) = market risk premium  = 0.1050 - 0.0450 = 0.060

​Substituting the values into equation (1), we have:

ERi = 0.0450 + 1.25(0.060) = 0.120 = 12%

Step 2: Calculation of current year dividend

D1 = Do × (1 + g) ........................................ (2)

Where;

D1 = current year dividend = ?

Do = last year dividend = $0.75

g = growth rate = 6.50% = 0.065

Substituting the values into equation (2), we have:

D1 = 0.75 × (1 + 0.065) = $0.79875

Step 3: Calculation of current stock price

The dividend growth model formula for calculating stock price is used as follows:

Stock price = D1 ÷ (ERi - g)

                   = $0.79875 ÷ (0.120 - 0.065)

                   =  14.5227272727273

Stock price = $14.52.

Therefore, the company's current stock price is $14.52.