Question

The Kosten Warenhaus just paid a dividend of $2.00 (D0 = $2.00)per share, and that dividend is expected to grow at a constant rate of 7.50% per year in the future. The company’s beta is 0.93, the market return is 9.0%, and the risk-free rate is 4.00%.

1. What is the required return on the stock, r_s? [Hint: Kj=Krf + B(Km – Krf)]

2. What is the company’s current stock price?

Answer 1

1.

We can find the required rate of return using CAPM method.

i.e Kj=Krf + B(Km – Krf)

Where,
Kj = Required rate of return
Krf = Risk Free rate of return
B = Betal
Km = Market return

Substituting the values in the formula, we get:

Kj = 4% + 0.93(9%-4%)
=4% + 0.93(5%)
=4% + 4.65%
= 8.65%

So required rate of return is 8.65%

2.

Calculation of current stock price:

Where,
P0 = Current stock price
D1 = coming year expected dividend
r = required rate of return which we already found (8.65%)
g = growth rate

D1 = D0 + g
= 2 + 7.5% of 2
= 2+ 0.15
= $2.15

Therefore, substituting the values in the formula, we get:

Therefore, current stock price = $186.96