Question

Chapter 13 Practice Test Question 17 Beta and Value A firm is expected to pay an annual dividend of $.60 next year. After next year the firm's dividends will grow at a steady state rate of 3% per year. You are trying to value the stock and Value Line lists a stock beta of 1.51 while Yahoo is reporting a beta of 1.44. The stock is currently priced at $13.30. If E(RM) - Rf = 4.8% and the risk free rate is 2.8% the stock is _ if you use the Value Line beta and is if you use the Yahoo beta. Multiple Choice underpriced by $1.33; underpriced by $1.63 o ) overpriced by $4.36; overpriced by $4.79 o underpriced by $1.63; underpriced by $1.33 o o overpriced by $4.79: overpriced by $4.36

Answer 1

line beta=   1.51
Risk free rate of return=   2.80%
Market expected Return- Riskfree=   4.80%
As per CAPM Expected rate of return (ke)= risk free rate + (Beta*(Market expected Return-risk free rate)  
2.8% + (1.51*4.8%))  
0.10048  
Expected Dividend=   0.6
Growth =   3%
Price as per line beta Cost of Equity = D1/(ke-g)  
0.6/(0.10048-0.03)  
8.513053348  
Price of stock=   13.3
it is overpriced by 13.3-8.51   $4.79
  
Yahoo beta=   1.44
ke = 2.8% +(1.44*4.8%)  
0.09712  
Price as per line beta Cost of Equity = D1/(ke-g)  
0.60/(0.09712-0.03)  
8.939213349  
it is over priced by 13.3-8.94=   $4.36

Anser is D