5) You are considering two stocks. Both pay a dividend of $1, but the beta coefficient of A is 1.5, while the beta coefficient of B is 0.7. Your required return is k=8%+(15%-8%)B

a) What is the required return for each stock?

b) If A is selling for $10 a share, is it a good buy if you expect earnings and dividends to grow at 5 percent?

c) The earnings and dividends of B are expected to grow annually at 10 percent. Would you buy the stock for $30?

d) If the earnings and dividends of A were expected to grow annually at 10 percent, would it be a good buy at $30?

Solution Preview

a) What is the required return for each stock?

You need to replace the beta coefficient for each stock in B of the equation.

For Stock A, the required return is

k = 8%+(15%-8%)1.5
k = 18.5%

For Stock B, the required return is

k = 8%+(15%-8%)0.7
k = 12.9%

b) If A is selling for $10 a share, is it a ...

Solution Summary

This solution is comprised of a detailed explanation and calculation to find the required return for each stock and the appropriate price of each stock.

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