Question

The risk-free rate of return is 5%, the required rate of return on the market is 15%, and High-Flyer stock has a beta coefficient of 1.4. If the dividend per share expected during the coming year, D1, is $3.92 and g = 5%, at what price should a share sell? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

Answer:

P0 = $28

Explanation:

Using the constant growth model of dividend discount model, we can calculate the price of the stock today. The DDM values a stock based on the present value of the expected future dividends from the stock. The formula for price today under this model is,

P0 = D1 / (r - g)

Where,

• D1 is the dividend expected for the next year

• g is the growth rate

• r is the required rate of return  

We first need to calculate r using the CAPM. This is the minimum return required by the investors to invest in a stock based on its systematic risk, the market's risk premium and the risk free rate.

The formula for required rate of return under CAPM is,

r = rRF + Beta * (rM - rRF)

Where,

• rRF is the risk free rate

• rM is the market rate of return

r = 0.05 + 1.4 * (0.15 - 0.05)

r = 0.19 or 19%

Now we can calculate the price of the stock today.

P0 = 3.92  /  (0.19 - 0.05)

P0 = $28