Required rate of return and market price of the stock

1. Rates of return and equilibrium - Stock C's beta coefficient is bc = 0.4, while Stock D's is bd = -0.5. (Stock D's beta is negative, indicating that its return rises when returns on most other stocks fall. There are very few negative beta stocks, although collection agency stocks are sometimes cited as an example.)
a. If the risk-free rate is 7 percent and the expected rate of return on an average stock is 11 percent, what are the required rates on Stocks C and D?
b. For Stock C, suppose the current price, Po, is $25; the next expected dividend , D1, is $1.50; and the stock's expected constant growth rate is 4 percent. Is the stock in equilibrium? Explain, and describe what would happen if the stock is not in equilibrium.

2. Two investors are evaluating GE's stock for possible purchase. They agree on the expected value of D1 and also on the expected future dividend growth rate. Further, they agree on the riskiness of the stock. However, one investor normally holds stocks for 2 years, while the other holds stocks for 10 years. On the basis of the type of analysis done in this chapter, should they both be willing to pay the same price for GE's stock?

Solution Preview

1. a)
Required rate of return = Risk free rate+ beta*(market return - risk free rate)
Required rate of return on stock C=7%+0.4*(11%-7%)= 8.6%
Required rate of return on ...

Solution Summary

This post answers two problems on security valuation. In the first problem, first we calculate the required rates of return on the stocks by using risk free rate and beta and then we evaluate whether the stock is correctly priced in the market or not. The second question is a conceptual question about the required rate of return desired by the two investors. The questions are explained with formula and calculations for easy understanding.

A stock has a beta of 1.5, themarket risk premium is 9%, andthe risk-free rate is 5%.
a. What is therequiredrate of return on this stock?
b. What is the expected return on themarket?
c. If based on your personal opinion thestock will generate a return of 20%, is thestock over-valued or under-valued? Would you buy or

Suppose therate of return on short-term government securities (perceived to be risk-free) is 5%. Suppose also that the expected rate of returnrequired by themarket for a portfolio with a beta of 1 is 12%. According to the CAPM
1. What is the expected rate of return on themarket portfolio?
2. Suppose you consider buyi

The risk-free rate of return is 3 percent, andthe expected return on themarket is 8.7 percent. Stock A has a beta coefficient of 1.4, an earnings and dividend growth rate of 5 percent, and a current dividend of $2.60 a share.
A) What should be themarketprice of thestock?
B) If the current marketprice of thestock is $2

A stock has a beta of 1.6, the risk free rate is 4% andthe expected marketreturn is 10%. What is therequiredrate of return using the CAPM model? If the expected return for thestock is 14%, would you recommend purchasing the shares now? Explain your answer in detail.

Woidtke Manufacturing's stock currently sells for $20 a share. Thestock just paid a dividend of $1.00 a share (i.e, D0 = $1.00). The dividend is expected to grow at a constant rate of 10% a year. What stockprice is expected 1 year from now? What is therequiredrate of return on the company's stock?

You expect the risk-free rate (RFR) to be 5 percent andthemarketreturn to be 12.2 percent. You also have the following information about three stocks
Current Expected Expected
Stock Beta PricePrice Dividend
X 1 26 26 0.75
Y 2 41.5 44 1.50
Z 2 50.00 58 0.95
What are the expected (required) r

42. If the expected rate of return on a stock exceeds therequiredrate
1. Thestock is experiencing supernormal growth
2. Thestock shoudl be sold
3. The company is probably not trying to maximize price per share
4. Thestock is a good buy
5. Dividends are not being declared
(Pick the best answer)

The preferred stock of the Clarence Radiology Company has a par value of $100 and a $9 dividend rate. You require an 11 percent rate of return on this stock. What is the maximum price you would pay for it? Would you buy it at a marketprice of $96?

Company x's stock currently sells for $20.00 a share. It just paid a dividend of $1.00 a share. The dividend is expected to grow at a constant rate of 6% a year. What stockprice is expected 1 year from now? What is therequiredrate of return?

Mary Lee, with Invest Inc. of Oklahoma City, is trying to sell you a stock with a current marketprice of $25.00. Thestocks last dividend (D) was $2.00, and earnings and dividends are expected to grow at a constant rate of 10%. If your requiredrate of return is 20%, should you buy or not buy this stock? Why?