Question

Miltmar Corporation will pay a year-end dividend of $4, and dividends thereafter are expected to grow at the constant rate of 6% per year. The risk-free rate is 6%, and the expected return on the market portfolio is 12%. The stock has a beta of 0.86.

a. Calculate the market capitalization rate. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

	Market capitalization rate. %

    

b. What is the intrinsic value of the stock? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

	Intrinsic value

Answer 1

Solution a :

Market capitalization rate is calculated using the following formula :

Market capitalization rate = R_F + [ β * ( R_M - R_F ) ]

Where

R_F = Risk free rate    ; β = Beta of the stock;   R_M = Expected return on the market portfolio

As per the information given in the question we have

R_F = 6 %   ; R_M = 12 %   ; β = 0.86

Applying the above values in the formula we have

= 6 % + [ 0.86 * ( 12 % - 6 % ) ]

= 6 % + [ 0.86 * 6 % ]

= 6 % + 5.16 % = 11.16 %

= 11.16 %

Thus the market capitalization rate is = 11.16 %

Solution b :

The formula for calculating the Intrinsic value of the stock is

= D₁ / (K_e – g )

As per the information given in the question we have

Year end Dividend = D₁ = $ 4

Growth rate = g = 6 % = 0.06

K_{e =} Market capitalization rate = 11.16 % = 0.1116

Applying the above values in the formula we have

Intrinsic value of the stock

= $ 4 / ( 0.1116 – 0.06 )

= $ 4 / 0.0516

= $ 77.5194

= $ 77. 52 ( when rounded off to two decimal places )

Thus the Intrinsic value of the stock = $ 77.52