Question

You have assigned the following values to these three firms: Price Upcoming Dividend Growth Beta US Bancorp $ 47.45 $ 2.95 6.60 % 1.80 Praxair 60.70 1.80 18.50 2.73 Eastman Kodak 46.25 2.00 7.80 0.75 Assume that the market portfolio will earn 10.80 percent and the risk-free rate is 3.00 percent. Compute the required return for each company using both CAPM and the constant-growth model. (Do not round intermediate calculations. Round your final answer to 2 decimal places.)

CAPM Constant-growth model

US Bancorp required return % %

Praxair required return % %

Eastman Kodak required return % %

Answer 1

Company	CAPM	Constant Growth
Stocks
US Bancorp	17.04%	12.82%
Praxair	24.29%	21.47%
Eastman Kodak	8.85%	12.12%

WORKING:

CAPM (see last column for returns):

Company	Risk free rate	Market Return	Beta	CAPM Working	Expected return
Stocks	Rf	Rm	B	Ri = Rf+B*(Rm-Rf)	Ri = Rf+B*(Rm-Rf)
US Bancorp	3.00%	10.80%	1.80	=3%+1.80*(10.8%-3%)	17.04%
Praxair	3.00%	10.80%	2.73	=3%+2.73*(10.8%-3%)	24.29%
Eastman Kodak	3.00%	10.80%	0.75	=3%+0.75*(10.8%-3%)	8.85%

Constant growth model or DDM (see last row for returns):

Given details	US Bancorp	Praxair	Eastman Kodak
Existing growth rate = g =	6.60%	18.50%	7.80%
Expected dividend = D1 = D0*(1+g) =	2.95	1.80	2.00
Expected rate = r = Cost of equity =	?	?	?
Current stock price = P0 =	47.45	60.70	46.25
Flotation cost = f =	0.00	0.00	0.00
Formula for calculating the Expected rate:
r = (D1/(P0-f))+g =	12.82%	21.47%	12.12%