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Stock price using CAPM and Dividend Discount Model

Ceejay Corporation's stock is currently selling at an equilibrium price of $30 per share. The firm has been experiencing a 6 percent annual growth rate. Last year's earnings per share, Eo, were $4.00 and the dividend payout ratio is 40%. The risk-free rate is 8%, and the market risk premium is 5%. If the market risk (beta) increases by 50%, and all other factors remain constant, what will be the new stock price? (Use 4 decimal places in calculations.)

A) $16.59
B) $18.25
C) $21.39
D) $22.69
E) $53.48

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Answer : D) $22.69

Step 1

We will first calculate the required rate of return r

Eo= $4.00

dividend payout ratio = 40%

Therefore Div0= $1.60 =40%*4

annual growth rate=g= 6%

Therefore Div1= next year's dividend= $1.6960 =(1+6%)*1.6

From the dividend capitalization model the price of share P0 is given by

Po= Div1/ (r-g)

Div1 = $1.6960 = dividend in year 1

r= ?

Solution Summary

The solution calculates stock price using CAPM and Dividend Discount Model