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Stock Price Determination- Capital Asset Pricing Model

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Augo Enterprises has a beta of 1.20 while the prevailing risk-free rate of interest is 10% and the required rate of return on the market portfolio is 14%. The company plans to pay a dividend of 2.60 per share next year and anticipates that future dividends will increase at an annual rate consistent with that experienced over the 1998-2003 period when the following dividends were paid.

Year Dividend per Share

2003 2.45
2002 2.28
2001 2.10
2000 1.95
1999 1.82
1998 1.80
1997 1.73

Given the above information:
a. Determine the required rate of return using the CAPM

b. Using the constant growth dividend valuation model along with the finding in part A. determine the intrinsic value of Augo's stock.

c. Discuss your results.

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Solution Preview

Augo Enterprises has a beta of 1.20 while the prevailing risk-free rate of interest is 10% and the required rate of return on the market portfolio is 14%. The company plans to pay a dividend of 2.60 per share next year and anticipates that future dividends will increase at an annual rate consistent with that experienced over the 1998-2003 period when the following dividends were paid.

Year Dividend per Share

2003 2.45
2002 2.28
2001 2.10
2000 ...

Solution Summary

Determines the required rate of return using the Capital Asset Pricing Model (CAPM) and then using the constant growth dividend valuation model determines the intrinsic value of stock.

$2.19
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See attached file for full problem description.

The beta of a stock is 1.2 and at the beginning of the year is selling for $55. The expected rate of return on the market portfolio is 9%, while the risk free rate of return is 3%. The stock is expected to pay a dividend of $2 at the end of the year. If the capital market is in CAPM equilibrium, what do you expect the price of the stock to be at the end of the year?

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