Question

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Questions 21-27 are based on the following information. CAPM and stock valuation. Your aunt, Beth, plans to invest in the common stock of Smart-investment Corporation Knowing that you are studying finance, she asks for your suggestion. You calculation shows that yield on Treasury securities is 6%. You know that the S&P 500 Index's expected annual return is 14% Your coonometric model tells you that beta of this company's stock is 1.25. Aunt Beth tells you that this company just paid an annual dividend of S2. After collecting as much information about this form as possible, you expect the firm's dividend will grow at an annual rate of 7% forever. The stock is sold for $25 per share for the time being 21. The firm's dividend of next year is expected to be a $1.75 b. 52.00 c. 52.14 d. 52.44 22. The market risk free rate is b. 7% c. 14% 23. The expected return of the market portfolio is a 6% b7% C 14 24. The beta, which is 1.25, in the problem is a total risk of the stock, and this stock is an aggressive stock b. total risk of the stock, and this stock is a defensive stock. c. Systematic risk of the stock, and this stock is an aggressive stock d. systematic risk of the stock, and this stock is a defensive stock. 25. The required rate of return of this stock is c. 16% d. 23.5% 26. The valuation of the stock is a S12.5 b SII 375 $22.22 d $21.78 27. Your suggestion to Aunt Beth is a. buy this stock because it is underpriced. b. do not buy this stock because it is overpriced c. neither a norb.

Answer 1

Solution 21:

Option c is correct.

The firm's next dividend, $D_{1}$ is calculated as follows:-

$D_{1} = D_{0} (1+g)$

$D_{1} = 2 (1.07) = $2.14$

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Solution 22:

Option a is correct.

The market risk free rate is 6% because the yield of Treasury securities is a proxy for the risk-free rate.

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Solution 23:

Option c is correct.

The expected return of the market portfolio is 14% because S&P 500 index is a proxy for the market portfolio.

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Solution 24:

Option a is correct.

Beta greater than 1 is considered to be an aggressive stock and it measures the total risk of an investment.