Question

IncorrectQuestion 14

0 / 1 pts

Given the following information:

Debt: 10000 bonds outstanding, maturity in 7 years, periodic (six-month) yield s 4%, annual coupon rate is 5%.

CS: One million shares outstanding, current market value is $20.00 per share, last annual dividend was $2.00 and the next dividend is expected to be $2.10 based upon the constant dividend growth model, the market risk premium is 7.0% and the risk-free rate is 3.5%.

Based upon the answer you obtained in the question above, what must beta be for the common stock?

  

greater than 1.9

  

between 1.8 nad 1.9

  

between 1.7 and 1.8

Answer 1

Using the dividend growth model we can calculate expected return on stock
P0 = D0*(1+g)/(Ke-g)
P0 is the price today
D0 is dividend paid today
g is growth rate
Ke expected return on stock
Growth rate	(2.10-2)/2
Growth rate	5.00%
20	2.1/(Ke-0.05)
20*(Ke-0.05)=2.1
20Ke - 1 = 2.10
20Ke = 3.10
Ke	15.50%
Thus, expected return on stock is 15.50%
Using the CAPM formula we would calculate beta of stock
Cost of equity (Ke)	Rf + Beta*(Rm-Rf)
Risk free rate is Rf
Market return is Rm
15.50% = 3.5% + 7%Beta
7%Beta = 15.50%-3.5%
7%Beta = 12%
Beta = 12%/7%
Beta = 1.71
Thus, beta is 1.71 which lies between 1.7 and 1.8