Question

You are assigned to estimate the share price of GNK Industries. The company's beta is 0.9, and the next dividend is expected to be $0.75 per share. The dividends are paid annually and are not expected to change. If the 10-year government bond yield is 1.5% and the market risk premium is 6.5%, what is GNK's fair share price?

Select one:

a. $8.44

b. $12.50

c. $10.20

d. $9.71

Answer 1

From CAPM We know that:

Expected Return = Risk Free Rate of Return(R_f) + (beta * Market risk premium)

Where, Market risk premium = Market Rate of Return (R_{m) -} Risk Free Rate of Return(R_f)

Here, 10-year government bond yield should be taken as the Risk Free Rate of Return(R_f)

Expected Return (R_i) = 1.5% + 0.9 * 6.5% = 7.35%

Next Expected Divided =$0.75,

Dividend are not expected to change, Hence dividend growth rate, g = 0

Using the Gordon growth model (GGM),

Price per Share= ​ Next Expected Divided / (Expected Return - Constant dividend growth rate)

= $0.75 / 7.35% = $10.20