Answer:
the intrinsic value of the stock is 42.97
If the stock is priced at 40 dollars it would be a good idea to purchase the share as will provide a better yield than the cost of capital of 9.6%
Explanation:
First, we solve for the cost of equity using the CAPM:
risk free = 0.03
market rate = 0.09
premium market = (market rate - risk free) = 0.055
beta(non diversifiable risk) = 1.2
Ke = 0.09600
<em>Now we solve for the intrinsic price using the gordon model</em>
<em>with multi-stage growth:</em>
First, we calcualte the future dividends
grow rate Dividends
0 1.25
1 0.25 1.5625
2 0.25 1.953125
3 0.25 2.44140625
4 0.25 3.051757813
4 0.03 3.143310547
Now in the last year, we calcualte using the gordon model or constant grow:
![\frac{3.143310547}{0.096-0.03} = Intrinsic \: Value](https://tex.z-dn.net/?f=%5Cfrac%7B3.143310547%7D%7B0.096-0.03%7D%20%3D%20Intrinsic%20%5C%3A%20Value)
32.7128182
Now we calculate and add together the present value of each of this future cash flow to determnate the intrinsic value ofthe share:
![\frac{Principal}{(1 + rate)^{time} } = PV](https://tex.z-dn.net/?f=%5Cfrac%7BPrincipal%7D%7B%281%20%2B%20rate%29%5E%7Btime%7D%20%7D%20%3D%20PV)
Present Value
1 1.5625 / (1+0.096)^1 = 1.425638686
2 1.953125 / (1+0.096)^2 = 1.625956531
and so on, giving the following values:
3 1.854421226
4 2.114987712
present value of the future dividends at 3% 22.67126448
<u>Finally we add them and get:</u>
42.97160726