The risk-free rate of return is 8 percent; the expected rate of return on the ma

Question

The risk-free rate of return is 8 percent; the expected rate of return on the market is 12 percent. Stock X has a beta coefficient of 1.3, an earnings and dividend-growth rate of 7 percent, and a current dividend of $2.40. If the stock is selling for $35, to decide if you think it is a good investment, what is your rate of return, and what is your required stock price? The risk-free rate of return is 8 percent; the expected rate of return on the market is 12 percent. Stock X has a beta coefficient of 1.3, an earnings and dividend-growth rate of 7 percent, and a current dividend of $2.40. If the stock is selling for $35, to decide if you think it is a good investment, what is your rate of return, and what is your required stock price?

Explanation / Answer

Required rate of return = Risk free rate + Beta ( Market return - Risk free return )

= 8+1.3(12-8) i.e 13.2%

Current dividend = 2.40

D1 = 2.40(1+0.07) i.e 2.568

Price of the stock = D1/Ke-G

= 2.568/13.2%-7% i.e 41.41

As current market price is less than the fair value of the stock , the stock is undervalued we should purchase it

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