Suppose the risk free rate is 4%. Suppose also that the expected return required by the market for a portfolio with a beta of 1.0 is 9%. Suppose you consider buying a share of stock at a price of $42. The stock is expected to pay a dividend of $3 next year and to sell then for $41. The stock risk has been evaluates at beta of 1.2.
(a) Is the stock overpriced or underpriced according to the capital asset pricing model?
(b) What might be the (current) fair price of the stock?© BrainMass Inc. brainmass.com October 17, 2018, 12:16 am ad1c9bdddf
The Capital Asset Pricing Model states that the rate of return of a stock=the risk-free rate+(beta*(the market rate of return-the risk-free rate). The excess of the market rate of return over the risk-free rate is called the market premium. Therefore, the rate of ...
Given the components of the capital asset pricing model and a stock's current and expected price, as well as its expected dividend, this solution illustrates how to value the stock using the capital asset pricing model, how to determine its total return, and how to determine if it is fairly priced by comparing the two computations.
Stock Value Using CAPM and DDM
Frazier Manufacturing paid a dividend last year of $2, which is expected to grow at a constant rate of 5%. Frazier has a beta of 1.3. If the market is returning 11% and the risk-free rate is 4%, calculate the
value of Frazier's stock.