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Bob's Burgers has a beta of .8 and just paid a dividend of $1.2 that is...

Bob's Burgers has a beta of .8 and just paid a dividend of $1.2 that is expected to grow at 3.5%. If the risk-free rate is 3% and the market risk premium is 6%, what should be the price of the stock?

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Expert Solution

Information provided:

Risk free rate= 3%

Market risk premium= 6%

Beta= 0.8

Current dividend= $1.2

Dividend growth rate= 3.5%

First, the required return on a stock is calculated using the Capital Asset Pricing Model (CAPM)

The formula is given below:

Ke=Rf+[E(Rm)-Rf]

where:

Rf=risk-free rate of return which is the yield on default free debt like treasury notes

Rm=expected rate of return on the market.

Rm-Rf= Market risk premium

= Stock’s beta

Ke= 3% + 0.8*6%

= 3% + 4.80%

= 7.80%

Price of the stock is calculated with the help of the dividend discount model.

It is computed using the below formula:

Share price=D1/(r-g)

where:

D1=next dividend payment

r=interest rate

g=firm’s expected growth rate

Share price= $1.2*(1 + 0.035)/ 0.078 – 0.035

= 1.2420/ 0.0430

= $28.88.

In case of any query, kindly comment on the solution

jeff jeffy answered 8 months ago

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