5. The companyâs common stock is going to pay a dividend is $2.00 per share after one year. Dividends are expected to grow at 10 percent per year for 2 years after that ($2.20 two years from now, and $2.42 3 years from now), and 4% thereafter.
The expected market return is 6%, your stock has a beta of 1.2. The return on riskless government bonds is 2%.
1. Assuming CAPM is correct, what should be the price of the stock?
2. Suppose the market price of the stock is $30 (different from the price that CAPM says it should be), what would you tell the investors about investing in the stock?
Concept Check: Capital is acquired in the marketplace. For many of us it is in the form of loans; publicly traded companies have access to debt in the form of bonds and equity in the form of stocks. In any instance we are being judged as to how much of a risk is the capital at for not being recovered. Risks include (but are not limited to); inflation or the erosion of the value of my money; opportunity costs in the form of interest free government securities, compensation for the chance of not being paid back (default risk), compensation for the length of time the capital is at risk (maturity) and compensation for the ability to be able to turn the investment of capital into cash by trading it or converting the obligation (liquidity risk).
Helpful Hint: We need to look at this from the market perspective of what is a fair rate of return for the investment compared to alternatives available.
5. The companyâs common stock is going to pay a dividend is $2.00 per share after one year. Dividends are expected to grow at 10 percent per year for 2 years after that ($2.20 two years from now, and $2.42 3 years from now), and 4% thereafter.
The expected market return is 6%, your stock has a beta of 1.2. The return on riskless government bonds is 2%.
1. Assuming CAPM is correct, what should be the price of the stock?
2. Suppose the market price of the stock is $30 (different from the price that CAPM says it should be), what would you tell the investors about investing in the stock?
Concept Check: Capital is acquired in the marketplace. For many of us it is in the form of loans; publicly traded companies have access to debt in the form of bonds and equity in the form of stocks. In any instance we are being judged as to how much of a risk is the capital at for not being recovered. Risks include (but are not limited to); inflation or the erosion of the value of my money; opportunity costs in the form of interest free government securities, compensation for the chance of not being paid back (default risk), compensation for the length of time the capital is at risk (maturity) and compensation for the ability to be able to turn the investment of capital into cash by trading it or converting the obligation (liquidity risk).
Helpful Hint: We need to look at this from the market perspective of what is a fair rate of return for the investment compared to alternatives available.
Related questions
1.
CAPM Required Return A company has a beta of.64. If the market return is expected to be 13.4 percent and therisk-free rate is 5.70 percent, what is the company's requiredreturn?
8.58%
16.33%
14.28%
10.63%
2.
P/E Ratio and Stock Price InternationalBusiness Machines (IBM) has earnings per share of $7.65 and a P/Eratio of 15.35. What is the stock price?
$46.00
$2.01
$117.43
$.50
3.
Suppose your firm is considering investing in a project with thecash flows shown below, that the required rate of return onprojects of this risk class is 10 percent, and that the maximumallowable payback and discounted payback statistic for the projectare 2 and 3 years, respectively.
| Time | 0 | 1 | 2 | 3 | 4 | 5 | 6 |
| CashFlow | -900 | 190 | 450 | 650 | 650 | 250 | 650 |
Use the PI decision rule to evaluate this project; should it beaccepted or rejected?
1.22%, accept
1.22%, reject
-122.00%, reject
122.12%, accept
4.
Compute the Payback statistic for Project X and recommendwhether the firm should accept or reject the project with the cashflows shown below if the appropriate cost of capital is 12 percentand the maximum allowable payback is 4 years.
| Time: | 0 | 1 | 2 | 3 | 4 | 5 |
| Cashflow: | -3,100 | 950 | 700 | 850 | 725 | 625 |
rev: 12_06_2012
3.83 years, Accept
2.83 years, Accept
3.83 years, Reject
2.83 years, Reject
