You are interested in purchasing the common stock of azure Corporation. The firm

Question

You are interested in purchasing the common stock of azure Corporation. The firm recently paid a dividend of $3 per share. It expects its earning - and its dividends to grow at a rate of 7% for the foreseeable future. Currently, similar risk socks have required returns of 10%. Given the data above, calculate the present value of this security. Use the con-stant-growth model (Equation 7.4) to find the stock value, One year later, your broker offers to sell you additional shares of Azure at 73. The most recent dividend paid was $3.21, and the expected growth rate for earnings remains at 7%. If you determine that the appropriate risk premium is 6.74% and you observe that the risk-free rate, Rf, is currently 5.25%, what is the firm's current required return, r Above? Applying Equation 7.4, determine the value of the stock using the new dividend and required return from part b. Given your calculation in part c, would you buy the additional shares from your broker at $73 per share? Explain. Given your calculation in part c, would you sell your old shares for $73 Explain.

Explanation / Answer

a) Price of the stock is Dividend/ required rate of return - growth rate

= 3 / (10% - 7%)

= 3/3% = $100

current required rate of return = Risk free rate + Beta * ( Market rate of return - risk free rate)

= 5.25% + 6.74%

= 11.99%

C) Value of stock = dividend / ( 11.99% - 7%)

= 3.21/4.99%

= $ 64.33

d) No, as the intrinsic value of share is less than $73, it is not advisable to buy the sahres.

E) YEs, as the $ 64.33 is the current value, selling the share at $ 73 would yield profits.

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