1. Franklin Corporation has a current stock price of $23 per share and paid a di

Question

1. Franklin Corporation has a current stock price of $23 per share and paid a dividend last year of $2.00; and, it expects that dividends, earnings and stock price to grow at the rate of 7%. In addition, Franklin has a Beta of 1.6, the expected return on the market is 13.2% and the risk free rate is 8%.
a. What is the estimated required return “r” using the dividend constant growth approach?
b. What is the estimated required return “r” using the CAPM approach?

2. Arid Corporation’s current stock price is $40.00, its next dividend will be $2.80, and its required rate of return is 12%. If dividends are expected to grow at a constant rate, g, in the future and if rs is expected to remain at 12%, what is Arid’s expected stock price 5 years from now?

Explanation / Answer

1. Franklin Corporation has a current stock price of $23 per share and paid a dividend last year of $2.00; and, it expects that dividends, earnings and stock price to grow at the rate of 7%. In addition, Franklin has a Beta of 1.6, the expected return on the market is 13.2% and the risk free rate is 8%. a. What is the estimated required return “r” using the dividend constant growth approach? b. What is the estimated required return “r” using the CAPM approach? a. rs = ((D0)(1 + g)/P0)) + g rs = ((2)(1.07)/23)) + .07 rs¬ = .1630 or 16.3% b. rs = rrf + (RPm)bi = rrf + (rm – rrf)bi = .08 + (.132 - .08)(1.6) = .1632 or 16.32%

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