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# CAPM to calculate XYZ's required rate of return

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Find an estimate of the risk-free rate of interest (krf). To obtain this value, go to Bloomberg.com: Market Data and use the "U.S. 10-year Treasury" bond rate (middle column) as the risk-free rate. In addition, you also need a value for the market risk premium. Use an assumed market risk premium of 7.5%.

Using the information from the XYZ Stock Information document, record the following values:
XYZ's beta
XYZ's current annual dividend
XYZ's 3-year dividend growth rate (g)
Industry P/E
XYZ's EPS

With the information you recorded, use the CAPM to calculate XYZ's required rate of return (ks).
Use the CGM to find the current stock price for XYZ. We will call this the theoretical price (Po).

Now use the XYZ Stock Information to find XYZ's current stock quote (P). Compare Po and P and answer the following questions:
Are there any differences?
What factors may be at work for such a difference in the two prices?
Now assume the market risk premium has increased from 7.5% to 10% and this increase is due only to the increased risk in the market. In other words, assume the krf and the stock's beta remain the same for this exercise.
What will the new price be? Explain.
Recalculate XYZ's stock price using the P/E ratio model and the needed info found in the XYZ Stock Information file.
Why is the present stock price different from the price arrived at using CGM (Constant Growth Model)?
If you used Microsoft Word to arrive at your answers, then you must provide an explanation of the formulas and calculations.

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#### Solution Preview

I have taken Visa as a company.

Information for Visa for the following:
Beta: 0.86
Current annual dividend : 0.5
3-year dividend growth rate (g) : 66% but I have normalized to 8%
Industry P/E : 26.3 times
http://moneycentral.msn.com/investor/invsub/results/compare.asp?Page=PriceRatios&symbol=US%3aV
EPS = 4.62
With the information you recorded, use the CAPM to calculate XYZ's required rate of return (ks).

the cost of equity for Visa= Here Beta of Visa= 0.86
Risk free rate=3.21%
http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/

Hence cost of equity As per CAPM= Risk free ...

\$2.19