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Dunder-Mifflin has a beta of 1.8 and just paid a dividend of $0.85 that is expected...

Dunder-Mifflin has a beta of 1.8 and just paid a dividend of $0.85 that is expected to grow at 3.5%. If the risk-free rate is 3% and the expected market return is 9%, what should be the price of the stock? A. $17.35 B. $8.54 C. $8.25 D. $17.95

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Expert Solution

Information provided:

Beta= 1.8

Current dividend= $0.85

Dividend growth rate= 3.5%

Risk free rate= 3%

Expected market return= 9%

First, the expected return 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.

= Stock’s beta

Ke= 3% + 1.8*(9% - 3%)

= 3% + 10.8%

= 13.80%

The price of the stock is calculated using the dividend dfiscount model.

Price of the stock= D1/(r-g)

where:

D1=next dividend payment

r=interest rate

g=firm’s expected growth rate

Price of the stock= $0.85*(1 + 0.035)/ 0.1380- 0.0350

= $0.8798/ 0.1030

= 8.54.

Hence, the answer is option b.

In case of any query, kindly comment on the solution.

jeff jeffy answered 6 months ago

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