Question

National Advertising just paid a dividend of D 0 = $1.25 per share, and that dividend is expected to grow at a constant rate of 6.50% per year in the future. The company's beta is 1.5, the required return on the market is 10.50%, and the risk-free rate is 4.50%. What is the company's current stock price?

a.

$16.64

b.

$17.26

c.

$18.89

d.

$19.02

Answer 1

Given,

Current dividend = $1.25

Growth rate (g) = 6.50% or 0.065

Beta = 1.5

Return on the market = 10.50%

Risk free rate = 4.50%

Solution :-

Expected return (r) = Risk free rate + beta(return on the market - risk free rate)

= 4.50% + 1.5(10.50% - 4.50%)

= 4.50% + 1.5(6.00%)

= 4.50% + 9.00% = 13.50% or 0.135

Expected dividend = Current dividend x (1 + g)

= $1.25 x (1 + 0.065)

= $1.25 x 1.065 = $1.33125

Now,

Current stock price = Expected dividend/(r - g)

= $1.33125/(0.135 - 0.065)

= $1.33125/0.07 = $19.02

Option 'd' is correct.