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Calculating price and constant growth rate of stock

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Philly Corp's stock recently paid a dividend of $2 per share (Do = $2), and the stock is in equilibrium. The company has a constant growth rate of 5% and a beta of 1.5. The required rate of return on the market is 15%, and the risk free rate is 7%. Philly is thinking of making a chance that will increase its beta coefficient to 1.75. If market conditions remain unchanged, what new constant growth rate will cause the common stock price of Philly to remain unchanged?

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Solution Summary

Solution describes the steps to calculate price of stock. It also calculates the constant growth rate which will keep the price estimate same even if beta is revised.

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Solution:

Dividend expected after 1 year=D1=D0*(1+g)=2*(1+5%)=$2.10
Given Beta=1.5
Krf=7%
Km=15%

CAPM model gives

Kr=Krf+beta*(km-krf)
=7%+1.5*(15%-7%)
=19.00% ...

Solution provided by:
Lokesh Jain, MSc
Education
  • BEng (Hons) , Birla Institute of Technology and Science, India
  • MSc (Hons) , Birla Institute of Technology and Science, India
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