Question

Given the following information for the stock of Foster​ Company, calculate the risk premium on its common stock.  ​

Current price per share of common stock

​$39.45

Expected dividend per share next year

​$3.59

Constant annual dividend growth rate

9.2​%

​Risk-free rate of return

4.9​%

the risk premium on Foster stock is ___% round to two decimal places

Answer 1

Let us first calculate the required return on equity using the Gordon Constant Growth Model,

Re = D1/ Po + g

= $3.59/ $39.45 + 0.092

= 18.3%

So, as per the CAPM model, the risk premium on the stock is:

Re = RF + Beta (Rm - Rf)

Risk premium = Re - risk free rate

= 18.3% - 4.9%

= 13.4%

So, the risk premium on the stock is 13.4%