Giant enterprises stock has a required return of 14.8%. The company which plans

Question

Giant enterprises stock has a required return of 14.8%. The company which plans to pay a dividend of $2.60 per share in the coming year, anticipate that its future dividends will increase at an annual rate consistent with that experienced over the 2009-2015 period, when the following dividends were paid.

A) If the risk-free rate is 10%, what is the risk premium on Giant's stock?

B) Using the constant-growth model, estimate the value of Giant's stock.

C) Expain what effect, if any, a decrease in the risk premium would have on the value of Giant's stock.

Year Dividend per share 2015 $2.45 2014 2.28 2013 2.10 2012 1.95 2011 1.82 2010 1.80 2009 1.73

Explanation / Answer

A) Risk premium = required return - risk-free rate = 14.8 - 10 = 4.8%

B) Growth rate = ( Future dividend - past dividend)/past dividend

Price = recent dividend* ( 1 + growth rate )/( required rate of return - growth rate)

= 2.6 * (1 + .06)/(0.148 - 0.06) = $31.31

C) Decrease in risk premium will decrease required rate of return of the stock causing price of stock to increase since as per dividend discount model price is inversely proportional to required rate.

Year Dividend per share Growth rate 2015 2.45 0.074561 2014 2.28 0.085714 2013 2.1 0.076923 2012 1.95 0.071429 2011 1.82 0.011111 2010 1.8 0.040462 2009 1.73 Average growth rate= 0.060033

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