Question

A share of common stock has just paid a dividend of $2.00. The market return is 15% and the beta is 2. The three month T-bill rate is 5%. The expected long-run growth rate for this stock is 15 percent. a. What is the required return for the stock? (hint: CAPM)

Answer 1

To calculate the required return for the stock using CAPM, you use the formula Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). With a risk-free rate of 5%, a beta of 2, and a market return of 15%, the required return is calculated to be 25%.

Step-by-step explanation:

Calculating the Required Return Using CAPM

The question asks to calculate the required return for the stock using the Capital Asset Pricing Model (CAPM). Based on the information provided, the dividend just paid is $2.00, the market return is 15%, the stock's beta is 2, the three-month T-Bill rate (risk-free rate) is 5%, and the expected long-term growth rate for the stock is also 15%. To find the required return using CAPM, we use the following formula:

Required Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate)

Inserting the given values, we get:

Required Return = 5% + 2 * (15% - 5%)

Required Return = 5% + 2 * 10%

Required Return = 5% + 20%

Required Return = 25%

Therefore, the required return for the stock, according to CAPM, is 25%. It is important to note that this calculation assumes the beta reflects the stock's volatility relative to the market and that the CAPM model is suitable for estimating the required return.