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2. (8 points) Sure Tool Company is expected to pay a dividend of $2 in the upcoming year. The risk-free rate of return is 4%

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Answer-

Sure Tool Company

Given

Dividend in the upcoming year (D1) = $ 2
Risk free rate (Rf) = 4 %
Market return portfolio (Rm) = 14 %
Beta of stock (B) = 1.25

CAPM

a)

Required rate of return (R) = Rf + B x ( Rm - Rf)

R = 4 % + 1.25 x ( 14 % - 4 %)

R = 4 % + 1.25 x 10%
R = 4 % + 12.5 %
R = 16.5 %

b)

Given

Intrinsic Value = V0 = $ 21
R = 16.5 % = 0.165
D1 = $ 2
Dividend growth rate (G) = ?
V0 = D1 / (R - G)

$ 21 = $ 2 / ( 16.5 % - G)

$ 21 = $ 2 / ( 0.165 - G)

0.165 - G = $ 2 / $ 21

0.165 - G = 0.09524

G = 0.165 - 0.09524

G = 0.06976

G = 6.976 %

The dividend growth rate = G = 6.976 %  

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