Question

A common stock pays an annual dividend per share of $1.80. The risk-free rate is 5%, and the risk premium for this stock is 4%. If the annual dividend is expected to remain at $1.80 per share, what is the value of the stock

Answer 1

The value of the stock today is $20

Step-by-step explanation:

Using the CAPM equation, we first calculate the required rate of retunr on the stock.

The equation for CAPM is,

r = rRF + Beta * rpM

Where,

• rRF is the risk free rate
• rpM is the risk premium on market
• Beta * rpM is the risk premium on stock

r = 0.05 + 0.04

r = 0.09 or 9%

The value of the stock can be calculated using the zero growth model of DDM. The DDM values the stock based on the present value of the expected future dividends from the stock. As the dividend from the stock is expected to remain constant through out to an indefinite period, the value of the stock today is,

P0 = Dividend / r

P0 = 1.8 / 0.09

P0 = $20