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?

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...