Question

Assume a major investment service has just given Oasis Electronics its highest investment​ rating, along with a strong buy recommendation. As a​ result, you decide to take a look for yourself and to place a value on the​ company's stock.​ Here's what you​ find: This​ year, Oasis paid its stockholders an annual dividend of ​$2.01 a​ share, but because of its high rate of growth in​ earnings, its dividends are expected to grow at the rate of 14​% a year for the next 4 years and then to level out at 11 % a year. So​ far, you've learned that the stock has a beta of 1.79​, the​ risk-free rate of return is 5​%, and the expected return on the market is 12​%. Using the CAPM to find the required rate of​ return, put a value on this stock.

Using the​ CAPM, the required rate of return on the investment is

17.53%. (Round to two decimal​ places.)

The value of the​ company's stock is $_____(Round to the nearest​ cent.)

Answer 1

The required rate of return on the investment using CAPM Approach

The Required Rate of Return = Rf + Beta(Rm – Rf)

= 5% + 1.79(12% - 5%)

= 5% + (1.79 x 7%)

= 5% + 12.53%

= 17.53%

The Value of the Company’s Stock

The Value of the Company’s Stock is the Present Value of the Future Dividend plus the present value of the share price in year4

Step-1, Dividend for the next 4 years

Dividend per share Year 1 (D1) = $2.29 per share ($2.01 x 114%)

Dividend per share Year 2 (D2) = $2.61 per share ($2.29 x 114%)

Dividend per share Year 3 (D3) = $2.98 per share ($2.61 x 114%)

Dividend per share Year 4 (D4) = $3.39 per share ($2.98 x 114%)

Step-2, Share Price in Year 4

Share Price in Year 4 (P0) = D4(1 + g) / (Ke – g)

= $3.39(1 + 0.11) / (0.1753 – 0.11)

= $3.77 / 0.0653

= $57.71 per share

Step-3, The Value of the company’s Stock

The Value of the Company’s Stock is the Present Value of the Future Dividend plus the present value of the share price in year4

= D1/(1 + r)¹ + D2/(1 + r)² + D3/(1 + r)³ + D4/(1 + r)⁴ + P4/(1 + r)⁴

= [$2.29 / (1 + 0.1753)¹] + [$2.61 / (1 + 0.1753)²] +[$2.98 / (1 + 0.1753)³] +[$3.39 / (1 + 0.1753)⁴] + [$57.71 / (1 + 0.1753)⁵]

= $1.95 + $1.89 + $ 1.83 + $1.78 + $30.24

= $37.70 per share

“Hence, the value of the​ company's stock would be $37.70”