The risk-free rate is 8% and the expected return on the market is 16%. As an ana

Question

The risk-free rate is 8% and the expected return on the market is 16%. As an analyst, you are preparing a recommendation report on the following two stocks:

                                                                                        Stock S                                 Stock B

                Beta                                                                       0.85                                        1.35

                Expected dividend next year                             $1.10                                      $4.00

                Growth rate (g)                                                     8%                                          6%

                Current Price (p0)                                                $22                                         $30.77

Following up 0n Question 9, draw the security market line showing the expected and required rates of return.

Explanation / Answer

Dividend discount approach k= (D/S)+G Where, k= required rate of return d= expected dividend payment next year s= Current stock price g= growth rate of dividend Stock A Stock B k= 13.00% k= 19.00% Capital asset procing model (CAPM) k= Rf + stock*(Rm -Rf ) Where, k= the required rate of return, or expected return Rf= risk free rate of return Rm= Return from the market stock= Beta of the stock Stock A Stock B k= 14.80% k= 18.80%

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