Question

The Red River just paid a dividend of Do = $1.00 per share, and that dividend...

The Red River just paid a dividend of Do = $1.00 per share, and that dividend is expected to grow at a constant rate of 7.00% per year in the future. The company's beta is 1.30, the market risk premium is 6.0%, and the risk-free rate is 5.00%. What is the company's current stock price?

$18.45

$17.62

$16.36

$15.12

$14.31
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Answer #1

Answer:

As per CAPM,
Cost of Equity = Risk Free Rate + Beta * Market Risk Premium
Cost of Equity = 5.00% + 1.30 * 6.00%
Cost of Equity = 5.00% + 7.80%
Cost of Equity = 12.80%

As per Constant Dividend Growth Model,
Cost of Equity = Expected Dividend / Current Price + Growth Rate

Current Dividend (D0) = $1.00
Growth Rate = 7.00%
Expected Dividend (D1) = $1.00 * (1 + 0.07)
Expected Dividend (D1) = $1.07

Cost of Equity = Expected Dividend / Current Price + Growth Rate
0.1280 = $1.07 / Current Price + 0.07
0.0580 = $1.07 / Current Price
Current Price = $18.45

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