Question

A company has just issued a dividend of $1.64 on earnings of $2.34. The analysts expect the dividends to grow at 5% forever. Investor’s observe a risk-free rate of 3%, stock’s beta is 1.5 and the market risk premium us 6%.

1. The expected return that investors will require on this stock is:
   1. 9%
   2. 10%
   3. 12%
   4. 15%
2. The current value of this stock is:
   1. $21.6
   2. $24.6
   3. $28.6
   4. $31.6
3. This stock may be considered a:
   1. Value stock, since its dividend yield is 5% and capital gains yield is 7%
   2. Value stock, since its dividend yield is 7% and capital gains yield is 5%
   3. Growth stock, since its dividend yield is 5% and capital gains yield is 7%
   4. Growth stock, since its dividend yield is 7% and capital gains yield is 5%

Answer 1

Answer a.

Expected Return, rs = Risk-free Rate + Beta * Market Risk Premium
Expected Return, rs = 3.00% + 1.50 * 6.00%
Expected Return, rs = 3.00% + 9.00%
Expected Return, rs = 12.00%

Answer b.

Last Dividend, D0 = $1.64
Growth Rate, g = 5.00%

Expected Dividend, D1 = D0 * (1 + g)
Expected Dividend, D1 = $1.64 * 1.05
Expected Dividend, D1 = $1.722

Current Value, P0 = D1 / (rs - g)
Current Value, P0 = $1.722 / (0.12 - 0.05)
Current Value, P0 = $1.722 / 0.07
Current Value, P0 = $24.60

Answer c.

This stock may be considered a Growth stock, since its dividend yield is 5% and capital gains yield is 7%.