The risk-free rate of return is 3 percent, and the expected return on the market is 8.7 percent. Stock A has a beta coefficient of 1.4, an earnings and dividend growth rate of 5 percent, and a current dividend of $2.60 a share.

A) What should be the market price of the stock?
B) If the current market price of the stock is $27, what should you do?
C) If the expected return on the market rises to 10 percent and the other variables remain constant, what will be the value of the stock?
D) If the risk-free return rises to 4.5 percent and the return on the market rises to 10.2 percent, what will be the value of the stock?
E) If the beta coefficient falls to 1.1 and the other variables remain constant, what will be the value of the stock?
F) Explain why the stock's value changes in c through e?

Solution Preview

Please refer attached file for better clarity.

a)
Risk Free Rate=rf=3%
Beta=b=1.4
Expected Market Return=rm=8.70%

Expected Return on stock=r=rf+b*(rm-rf)=10.98%
Growth Rate=g=5%
Current Dividend=Do=$2.60

Expected dividend next year=D1=Do*(1+g)=$2.73

Current Market price of stock=Po=D1/(r-g)=$45.65

b)
Current market price is lower than estimated price, ...

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