Question

Two stocks each pay a $1 dividend that is growing annually at 4 percent. Stock A's beta = 1.3; stock B's beta = 0.8.

a. Which stock is more volatile?

b. If Treasury bills yield 2 percent and you expect the market to rise by 8 percent, what is your risk-adjusted required return for each stock?

c. Using the dividend-growth model, what is the maximum price you would be willing to pay for each stock?

d. Why are their valuations different?

Answer 1

A. Stock A beta is higher and it is more volatile.

B. Expected rate of return= risk free rate+(beta (market rate of return - risk free rate)

A= 2+(1.3*6)=9.8%

B= 2+(.8*6)= 6.8%

3. Stock A= dividend paid at next year/(required rate of return- growth rate)

=( 1*104%/5.8%)=17.93

Stock B= (1*104%)/2.8%=37.14

4.prices of both stocks at different because they have different expected rate of return and risk associated with them and different beta.