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Question about Equilibrium Stock Price

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Please help with the following problem:

The risk-free rate of return, rRF, is 11%; the required rate of return on the market, rM, is 14%; and Schuler Company's stock has a beta coefficient of 1.5.

a) If the dividend expected during the coming year, D1, is $2.25, and if g = a constant 5%, at what price should Schuler's stock sell?

b) Now, suppose the Federal Reserve Board increases the money supply, causing the risk-free rate to drop to 9% and rM to fall to 12%. What would this do to the price of the stock?

c) In addition to the change in part b, suppose investors' risk aversion declines; this fact, combined with the decline in rRF, causes rM to fall to 11%. At what price should Schuler's stock sell?

d) Now, suppose Schuler has a change in management. The new group institutes policies that increase the expected constant growth rate to 6%. Also, the new management stabilizes sales and profits, and thus causes the beta coefficient to decline from 1.5 to 1.3. Assume that rRF and rM are equal to the values in part c. After all these changes, what is Schuler's new equilibrium price? (Note: D1 goes to $2.27).

Thank you.

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Solution Summary

The solution explains how to determine the equilibrium stock price under different conditions.

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