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

$2.55

a share, but because of its high rate of growth in earnings, its dividends are expected to grow at the rate of
12 %
a year for the next 4 years and then to level out at
9 %
a year. So far, you've learned that the stock has a beta of
1.64 ,
the risk-free rate of return is
5 %,
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

Share price : $ 56.23

Step-by-step explanation:

CAPM

`Ke= r_f + \beta (r_m-r_f)`

risk free = 0.05

market rate = 0.11

premium market = (market rate - risk free) 0.06

beta(non diversifiable risk) = 1.64

`Ke= 0.05 + 1.64 (0.06)`

Ke 0.14840

Now, we solve for the present value of the future dividends:

year dividend* present value**

1 2.91 2.53

2 3.31 2.51

3 3.78 2.49

4 4.31 2.48

4 80.38 46.22

TOTAL 56.23

*Dividends will be calculate as the previous year dividends tiems the grow rate

during the first four year is 14%

then, we calcualte the present value of all the future dividends growing at 9% using the dividend grow model:

`(D_1)/(K_e-g)`

(4.31 x 1.09) / (0.1484 - 0.09) = 80.38

Then we discount eahc using the present value of a lump sum:

`(Cashflow)/((1 + rate)^(time) ) = PV`

We discount using the CAPM COst of Capital of 14.84%

last we add them all to get the share price: $ 56.23