Question

Assume a major investment service has just given Oasis Electronics its highest investment​ rating, along with a strong buy recommendation. As a​ result, you decide to take a look for yourself and to place a value on the​ company's stock.​ Here's what you​ find: This​ year, Oasis paid its stockholders an annual dividend of ​$2.49 a​ share, but because of its high rate of growth in​ earnings, its dividends are expected to grow at the rate of 11​% a year for the next 4 years and then to level out at 8% a year. So​ far, you've learned that the stock has a beta of1.69​,the​ risk-free rate of return is 7​%, and the expected return on the market is 11​%. Using the CAPM to find the required rate of​ return, put a value on this stock.

Answer 1

Required return=risk free rate+beta*(market rate-risk free rate)

=7+1.69*(11-7)=13.76%

D1=(2.49*1.11)=2.7639

D2=(2.7639*1.11)=3.067929

D3=(3.067929*1.11)=3.40540119

D4=(3.40540119*1.11)=3.77999532

Value after year 4=(D4*Growth rate)/(Required return-Growth rate)

=(3.77999532*1.08)/(0.1376-0.08)

=70.8749122

Hence value of stock=Future dividend and value*Present value of discounting factor(rate%,time period)

=2.7639/1.1376+3.067929/1.1376^2+3.40540119/1.1376^3+3.77999532/1.1376^4+70.8749122/1.1376^4

=$51.69(Approx).