Question

1) Shanz Enterprises has a beta of 1.28, the real risk-free rate is 2.00%, investors expect a 3.00% future inflation rate, and the market risk premium is 4.70%. What is Kollo's required rate of return? *

a) 11.016%

b) 9.670%

c) 9.920%

d) 10.170%

e) None of the above

2) An issue of common stock’s most recent dividend is $1; its growth rate is 5%. What is its price if the required rate of return is 10%? *

a) $21

b) $87.5

c) $92.5

d) $0

e) None of the above

Answer 1

1).

Using CAPM, required rate of return can be calculated as rf+Beta*(market risk premium), where rf is nominal risk free rate.

Given that real risk free rate is 2% and expected inflation rate is 3%. So, nominal risk free rate is calculated by adding inflation rate to real risk free rate. So, nominal risk free rate= 2%+3%= 5%

So, required rate of return= 5%+(1.28*4.7%)

= 5%+6.016%

= 11.016% (Option a)

2).

Using Dividend discount model, price of a stock is calculated as D1/(r-g), where D1 is dividend paid next yaer, r is required rate of return and g is dividend growth rate.

Given that most recent dividend is $1. So, Dividend paid next year= 1*(1+5%)= 1.05

So, Price of the stock = 1.05/(10%-5%)

= 1.05/0.05

= $21 (Option a)