chapter 10 question 11 You have assigned the following values to these three fir
ID: 2715907 • Letter: C
Question
chapter 10 question 11
You have assigned the following values to these three firms:
Assume that the market portfolio will earn 11.00 percent and the risk-free rate is 4.00 percent.
Compute the required return for each company using both CAPM and the constant-growth model. (Do not round intermediate calculations and round your final answers to 2 decimal places.)
Price Upcoming Dividend Growth Beta US Bancorp $ 51.35 $ 2.25 7.00 % 1.78 Praxair 41.60 1.55 20.50 1.96 Eastman Kodak 43.15 2.00 8.40 0.84
Explanation / Answer
CAPM to determine each firm’s required return:
US Bancorp required return = 3.5% + 0.8 × (12% 3.5%) = 10.3%
Praxair required return = 3.5% + 0.7 × (12% 3.5%) = 9.45%
Eastman Kodak required return = 3.5% + 2.0 × (12% 3.5%) = 20.5%
Now compute the required return using the constant growth rate model:
US Bancorp required return =
Praxair required return =
Eastman Kodak required return =
The US Bancorp CAPM estimate of 10.3% is low compared to the 14.4% constant growth rate model estimate. The CAPM estimate for Praxair is high compared to the constant growth rate model estimate. The CAPM estimate for Eastman Kodak is more than double that of the constant growth rate model.
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