Question

1.What is the most you would be willing to pay for a stock with a beta of 2.2 that is expected to pay a dividend of $0.80 be worth $135 next year if the risk-free rate is 2% and the expected market return is 8%?

2.You find a stock with a beta of 1.8 that is expected to be priced at $113 next year and pay a dividend of $2.25. If the risk-free rate is 3% and the expected market return is 9%, what is the most you would be willing to pay for the stock today?

Answer 1

1.

As per CAPM

expected return = risk-free rate + beta * (expected return on the market - risk-free rate)

Expected return% = 2 + 2.2 * (8 - 2)

Expected return% = 15.2

Price today = (price in 1 year + dividend)/(1+expected return) = (135+0.8)/(1+.152) =  117.88

2.

As per CAPM

expected return = risk-free rate + beta * (expected return on the market - risk-free rate)

Expected return% = 3 + 1.8 * (9 - 3)

Expected return% = 13.8

Price today = (price in 1 year + dividend)/(1+expected return) = (113+2.25)/(1+.138) =  101.27