In: Finance
Answer to a
According to CAPM or Capital Asset Pricing Model:-
Required Retrun on a Stock = Risk Free rate +(Market Risk Premium)* Beta of the stock.
Where,
RIsk Free Rate = 3.5%
Market Risk Premium = 4%
Beta of the Stock = 1.3
Now Required Rate of Return = 3.5 + 4*(1.3) = 8.7%.
Therefore the Required Rate of Return on Treadwater's Stock is 8.7%.
Answer to b
Given that the company has a zero growth rate this means that all dividends paid by the stock remains the same through out and therefore the value of Stock is determined by using the below formula
Value of Stock = Dividend / Required Rate of Return
where we have the Divided= $3 and the Required rate of return as computed above is 8.7%.
Now Value of Stock = $3 / 8.7%
Value of Stock = $ 34.483
Answer to c
We have the Beta of the Stock revised to 1.6 and the market risk premium is increased to 6%. therefore we now compute the Required rate of retrun of the stock.
According to CAPM or Capital Asset Pricing Model:-
Required Retrun on a Stock = Risk Free rate +(Market Risk Premium)* Beta of the stock.
Where,
RIsk Free Rate = 3.5%
Market Risk Premium = 6%
Beta of the Stock = 1.6
Required Rate of Return of the stock = 3.5 + 6*(1.6)
Required Rate of Return of the stock = 13.1%
Now, let us now compute the value of Stock using the same forumla as used in part b
Value of Stock = $3 / 13.1% = $22.90
Therefore the revised value of stock = $22.90.