The current risk-free rate of return is 1%. You want to value a company's stock that pays an annual dividend of $1.25

The current risk-free rate of return is 1%. You want to value a company's stock that pays an annual dividend of $1.25 and has an expected growth rate of 3%. Given your investment strategy, you require a risk premium of at least 6% on any company you invest in. Based on the Gordon Growth Model, what is the most you'd be willing to pay for this company's stock?

Expert Solution

As Per CAPM

Expected Return = Risk Free Return +( Market Return - Risk Free Return) * Beta

Risk Premium , (Rm-Rf)*Beta	6.00%
Risk Free Rate ,Rf	1.00%
Cost Of Equity,Ke = Rf + (Rm-Rf)*Beta	7.00%

Now we will calculate the value willing to pay for this stock.

Cost Of Equity,Ke	7.00%
Growth Rate,G	3%
Recent Dividend ,D0	1.25
Expected Dividend , D1 = D0*(1+G)	1.2875
Stock Value =D1/(Ke-g)	32.19

The value willing to pay for this stock = $32.19.

Junaid answered 2 years ago

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