Assume the beta coefficient for a company’s stock is β = 0.2, the risk-free rate of return, rRF, is 8% and the required rate of return on the market, rM, is 14%. Assume the dividend expected during the coming year is D1 = $2.50 and the growth rate is a constant 7%. Complete parts (a) through (c) below.
a) Compute the price at which the company’s stock should sell.
b) Find the new price of the stock assuming the risk-free rate of return is 5% and the required rate of return on the market is 11%.
c) What would be needed for a stock to be in equilibrium?
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SOLUTION:
a)
Ke = Rf + Beta * (Rm - Rf)
Ke = 8% + 0.2 * (14% - 8%)
Ke
9.20%
P = D / (Ke - g)
P = $2.50 / (9.20% - 7%)
P
b)
$113.64
Ke = Rf + Beta * (Rm - Rf)
Ke = 5% + 0.2 * (11% - 5%)
Ke...