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In: Finance

You are considering a stock A that pays a dividend of $1. The beta coefficient of...

You are considering a stock A that pays a dividend of $1. The beta coefficient of A is 1.3. The risk free return is 6%, while the market average return is 13%.

a.What is the required return for Stock A?

b. If A is selling for $10 a share, is it a good buy if you expect earnings and dividends to grow at 6%?

Solutions

Expert Solution

a. Required return for Stock A 15.10%
Working:
As per Capital Asset Pricing model,
Required return = Risk free rate + Beta * (Market return - Risk free return)
= 6% + 1.3 * (13%-6%)
= 15.10%
b. Yes
Working:
As per dividend discount model, current price of stock is the present value of future dividends which is calculated as follows:
Price of stock = D0*(1+g)/(Ke-g) Where,
= 1.00*(1+0.06)/(0.1510-0.06) D0 Current dividend = $       1.00
= $    11.65 g Growth rate in dividend = 6%
Ke Discount rate = 15.10%
Current value of stock A is $ 11.65.But, it is selling at $ 10.It means that share is undervalued and it is good time to buy such stock.

jeff jeffy answered 3 months ago
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