Question

Assume a major investment service has just given Big Lake Realty 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, Big Lake paid its stockholders an annual dividend of ​$4.93 a​ share, but because of its high rate of growth in​ earnings, its dividends are expected to grow at the rate of 9​% a year for the next five years and then to level out at 5 % a year. So​ far, you've learned that the stock has a beta of 1.15​, the​ risk-free rate of return is 4.8​%, and the expected return on the market is 10.8​%.

Using the CAPM to find the required rate of​ return, put a value on this stock.

Answer 1

Required Ret = Rf + Beta ( Rm - Rf )

= 4.8% + 1.15 [ 10.8% - 4.8% ]

= 4.8% + 1.15 [ 6% ]

= 4.8% + 6.9%

= 11.7%

Value of STock = PV of CFs from it.

Div Calculation:

Year	CF	Formula	Calculation
1	$      5.37	D0(1+g)	4.93*1.09
2	$      5.86	D1(1+g)	5.37*1.09
3	$      6.38	D2(1+g)	5.86*1.09
4	$      6.96	D3(1+g)	6.38*1.09
5	$      7.59	D4(1+g)	6.96*1.09
6	$      7.96	D5(1+g)	7.59*1.05

P5 = D6 / [ Ke - g ]

= 7.96 / [ 11.7% - 5% ]

= 7.96 / 6.7%

= 118.81

P0 Calculation:

Year	CF	PVF @11.7%	Disc CF
1	$      5.37	0.895255	$      4.81
2	$      5.86	0.801482	$      4.69
3	$      6.38	0.717531	$      4.58
4	$      6.96	0.642373	$      4.47
5	$      7.59	0.575088	$      4.36
5	$ 118.81	0.575088	$   68.33
Value of Stock			$   91.25