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Current Stock Price using CAPM and DDM

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A company currently pays a dividend of $2 per share, D0=2. It is estimated that the company's dividend will grow at a rate of 20 percent per year for the next 2 years, then the dividend will grow at a constant rate of 7 percent thereafter. The company's stock has a beta equal to 1.2, the risk-free rate is 7.5 percent, and the market risk premium is 4 percent. What would you estimate is the stock's current price?

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Solution Preview

First we calculate required rate of return using CAPM equation
r= r f + beta x (r m - r f)

r f = 7.5%
beta= 1.2
r m = 11.5% =7.5%+4%
r = ? To be determined
Substituting the ...

Solution Summary

The solution calculates the stock price first by calculating the required rate of return using CAPM (Capital Asset Pricing Model) and then arrives at the stock price using Dividend Discount Model (DDM) - discounts the dividends using the discount rate = required rate of return.

$2.19