12.4 Assume the risk-free rate is 6 percent and the market risk premium is 6 per

Question

12.4 Assume the risk-free rate is 6 percent and the market risk premium is 6 percent the stock of Physicians Care Network has a beta of 1.5. The last dividend paid by PCN (Do) was $2 per share.

a). what would pcn stock value be if the dividend was expected to grow as constant

               -5%?

               0%?

               5%?

               10%?

b). what would be the stock value if the growth rate is 10%, but pcns beta falls to:

               1.0?

0.5?

12.9

California Clinics, an investor-owned chain of ambulatory are clinics, just paid a dividend of $2 per share. The firms dividend is expected grow at a constant rate of 5% per year and investors required a 15% rate of return on the stock.

a). what is the stock value?

b). Suppose the riskiness of the stock decreases, which causes the required rate of return to fall to 13%. Under conditions, what is the stock’s value?

c). Return to the original 15% required rate of return .Assume that the divided growth rate estimate is increased to a constant 7 percent per year. What is the stock’s value?

Explanation / Answer

12.4

a)

First we have to calulate the cost of equity (Ke)

Ke = Risk free rate+Beta*(market risk premium)

=6%+1.5*6%

=15%

Expected to grow at a constant - 5%:

Price of stock = dividend*(1+growth rate)/(Ke-growth rate)

=(2*(1-5%))/(15%-(-5%))

=$9.50

Expected to grow at a constant 0%:

=(2*(1+0%))/(15%-0%)

=$13.33

Expected to grow at a constant 5%:

=(2*(1+5%))/(15%-5%)

=$21

b)

(i)

(Taking Growth (g) 10% and beta 1.0)

Ke = RF + MRP*B

Ke = 0.06+0.06*1.0 = 0.12 = 12%

Price = D0*(1+g)/Ke

Price = 2(1.10)/0.12 = $18.33

(ii)

(Taking Growth (g) 10% and beta 0.5)

Ke = RF + MRP*B

Ke = 0.06+0.06*0.5 = 0.09 = 9%

Price = D0*(1+g)/Ke

Price = 2(1.10)/0.09 = $24.44

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