Question

The risk-free rate of return is 5%, the required rate of return on the market is 10%, and High-Flyer stock has a beta coefficient of 1.8. If the dividend per share expected during the coming year, D1, is $2.20 and g = 4%, at what price should a share sell? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

The price of a share of High-Flyer stock can be calculated using the dividend discount model:

P0 = D1 / (r - g)

where P0 is the current price of the stock, D1 is the dividend per share expected during the coming year, r is the required rate of return on the market, and g is the expected growth rate of the dividend.

First, we need to calculate the required rate of return on High-Flyer stock:

rHF = rRF + βHF(rM - rRF)
= 0.05 + 1.8(0.10 - 0.05)
= 0.13

where rRF is the risk-free rate of return, rM is the required rate of return on the market, and βHF is the beta coefficient of High-Flyer stock.

Next, we can use the dividend discount model to calculate the price of a share of High-Flyer stock:

P0 = D1 / (r - g)
= 2.20 / (0.13 - 0.04)
= 22.00

Therefore, a share of High-Flyer stock should sell for $22.00.