Question

6. Gurley Enterprises’ stock has a required return of 13.40%. The company, which plans to pay a dividend of $3.00 per share in 2019, anticipates that its future dividends will increase at an annual rate consistent with that experienced over the 2012-2018 period, when the following dividends were paid:

Year	Div per Shr
2012	$2.15
2013	$2.20
2014	$2.20
2015	$2.33
2016	$2.44
2017	$2.60
2018	$2.80

1. If the risk-free rate is 5%, what is the risk premium on Gurley’s stock?
2. Using the constant-growth model, estimate the value of Gurley’s stock.

Answer 1

Year	Dividend
2012	$     2.15
2013	$     2.20
2014	$     2.20
2015	$     2.33
2016	$     2.44
2017	$     2.60
2018	$     2.80
As we can see that the dividend grew from 2.15 to 2.80 in 6 years
2.80=	2.15*(1+r)^6
R=	((2.80/2.15)^(1/6))-1)
R=	0.045009
R=	4.50%

Current Dividend	$         3.00
Rate of return	13.40%
Growth Rate	4.50%
Share Price as per Dividend discount model	=Current Dividend*(1+Growth rate)/(Rate of return-Growth Rate)
Share Price as per Dividend discount model	=3*(1+0.045)/(0.134-0.045)
Share Price as per Dividend discount model	$       35.22

Since the risk-free rate is 5%, and the required return on the stock is 13.40%, the risk premium will be 8.40%.