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    THEORETICAL STOCK PRICES

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    Find an estimate of the risk-free rate of interest (krf). To obtain this value, go to Bloomberg.com: Market Data and use the "U.S. 10-year Treasury" bond rate (middle column) as the risk-free rate. In addition, you also need a value for the market risk premium. Use an assumed market risk premium of 7.5%.
    â?¢Download the XYZ Stock Information by clicking the link.
    â?¢Using the information from the XYZ Stock Information document, record the following values:
    â-¦XYZ's beta (Ã?)
    â-¦XYZ's current annual dividend
    â-¦XYZ's 3-year dividend growth rate (g)
    â-¦Industry P/E
    â-¦XYZ's EPS
    â?¢With the information you recorded, use the CAPM to calculate XYZ's required rate of return (ks).
    â?¢Use the CGM to find the current stock price for XYZ. We will call this the theoretical price (Po).
    â?¢Now use the XYZ Stock Information to find XYZ's current stock quote (P). Compare Po and P and answer the following questions:
    â-¦Are there any differences?
    â-¦What factors may be at work for such a difference in the two prices?
    â?¢Now assume the market risk premium has increased from 7.5% to 10% and this increase is due only to the increased risk in the market. In other words, assume the krf and the stock's beta remain the same for this exercise.
    â-¦What will the new price be? Explain.
    â?¢Recalculate XYZ's stock price using the P/E ratio model and the needed info found in the XYZ Stock Information file.
    â-¦Why is the present stock price different from the price arrived at using CGM (Constant Growth Model)?
    â?¢If you used Microsoft Word to arrive at your answers, then you must provide an explanation of the formulas and calculations.

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    An estimation of the 10 year treasury rate is 2.558%, found here http://finance.yahoo.com/q?s=%5ETNX.

    For simplicity, we assume it is 2.6%.

    60 month beta = 1.64

    Current Annual dividend = 0.8

    3 year div. growth = 8.2%.

    Industry P/E = 23.2

    XYZ's P/E = 15.65.

    By CAPM, we know that E(stock) = rf + beta(market risk premium) = 0.026 + 1.64 X 0.075 = 14.9%, this is the company's required rate ...

    Solution Summary

    THEORETICAL STOCK PRICES AND HOW THEY REACT TO MARKET FORCES

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