Question

Rivertown Inc. paid a dividend of $.80 last year. The company expects to increase the dividend at a constant rate of 5% per year, indefinitely. The stock price is $9.13 currently, with a beta of 0.85. The market risk premium is 12% and the risk-free rate is 4%. What will the price of Rivertown's stock be if its beta falls to 0.8?

Answer 1

Price of stock = $8.75

Step-by-step explanation:

The price of a stock using the dividend valuation model is the present value of the the future dividends expected from the stock discounted at the required rate of return.

This model is represented as follows

P = D(1+g)/(r-g)

P- price, ?

D- dividend payable now- $0.8

g - growth rate in dividend- 5%

r- cost of equity ?

Cost of equity can calculated using the Capital asset pricing model(CAPM)

Ke= Rf +β(Rm-Rf)

Ke =? , Rf- 4%, β- 0.8, (Rm-Rf)- 12%

Ke= 4% + 0.8× 12%

Ke =13.6%

Price of stock

= 0.80 × (1.05)/(0.136-0.04)

= $8.75