The risk free rate of return is 3% and the market rate of return is 12%. Penn Tr

Question

The risk free rate of return is 3% and the market rate of return is 12%. Penn Trucking has a beta of 2 and a standard deviation of returns of 28%. Penn Trucking's marginal tax rate is 35%. Analysts expect Penn Trucking's dividends to grow by 6% per year for the foreseeable future.

a) What is the risk premium?

b) Using the capital asset pricing model, what is Penn Trucking's required rate of return on its common stock?

c) If Penn has a current return of 21% and has just paid a dividend of $1.50, what is the value of its stock?

Explanation / Answer

a> Risk Premium=12-3=8% b>Required Rate of Return=Risk FreeRate+Beta*(Market Rate-Risk Free Rate) =3+2*(12-3) 21 or 21% c> Price=Dividend/Cost of Capital=1.5/0.21 7.14

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