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 2.16 a share but because of its high rate of growth in earnings, its dividends are expected to grow at the rate of 12% a year for the next 4 years and then level out at 9% a year. So far you've learned that the stock has a beta of 1.66, the risk-free rate of return is 6%, 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.

1. Using the CAPM, the required rate of return on the investment is _______ % ? (Round to two decimal places)

2. The value of the companies stock is $_____. (Round to the nearest cent)

Please help, thank you!

Answer 1

1

As per CAPM

expected return = risk-free rate + beta * (expected return on the market - risk-free rate)

Expected return% = 6 + 1.66 * (12 - 6)

Expected return% = 15.96

2

	Required rate=	15.96%
Year	Previous year dividend	Dividend growth rate	Dividend current year	Horizon value	Total Value	Discount factor	Discounted value
1	2.16	12.00%	2.4192		2.4192	1.1596	2.0862
2	2.4192	12.00%	2.709504		2.709504	1.34467216	2.01499
3	2.709504	12.00%	3.03464448		3.03464448	1.559281837	1.94618
4	3.03464448	12.00%	3.398801818	53.228	56.62680182	1.808143218	31.31765
	Long term growth rate (given)=	9.00%			Value of Stock =	Sum of discounted value =	37.37

Where
Current dividend =Previous year dividend*(1+growth rate)^corresponding year
Total value = Dividend + horizon value (only for last year)
Horizon value = Dividend Current year 4 *(1+long term growth rate)/( Required rate-long term growth rate)
Discount factor=(1+ Required rate)^corresponding period
Discounted value=total value/discount factor