Answer the following questions and put calculations: 5. The following informatio
ID: 2802280 • Letter: A
Question
Answer the following questions and put calculations:
5. The following information is available in general about investments in stocks J and K.
The market return (kM)
= 9%
The risk free rate (kRF)
= 5%
Stock J's beta
= 0.8
Expected constant growth rate for Stock J
= 6%
Investment in Stock J
= $80,000
Stock K's beta
= 1.4
Expected constant growth rate for Stock K
= 7%
Investment in Stock K
= $120,000
a)
What are the expected returns on Stock J and Stock K individually?
b)
What is the expected return on the portfolio?
c)
If Stock K just paid a dividend of $2.50, what is Stock K's intrinsic value?
6. SMK Broadcasting is thinking about increasing its current dividend from $1.00 to either $1.07 (a seven percent growth rate) or $1.10 (a ten percent growth rate). Once it adopts the change, SMK wants to maintain the same dividend growth rate for the foreseeable future. Hence, the required return with the higher growth rate is 16%, while the required return with the lower growth rate is 13%. Which dividend adjustment will result in a higher price for SMK Broadcasting's common stock?
The market return (kM)
= 9%
The risk free rate (kRF)
= 5%
Stock J's beta
= 0.8
Expected constant growth rate for Stock J
= 6%
Investment in Stock J
= $80,000
Stock K's beta
= 1.4
Expected constant growth rate for Stock K
= 7%
Investment in Stock K
= $120,000
Explanation / Answer
Answer 5-a.
Stock J:
Market Return, kM = 9%
Risk-free Rate, kRF = 5%
Beta = 0.80
Expected Return = Risk-free Rate + beta * (Market Return - Risk-free Rate)
Expected Return = 5% + 0.80 * (9% - 5%)
Expected Return = 8.20%
Stock K:
Market Return, kM = 9%
Risk-free Rate, kRF = 5%
Beta = 1.40
Expected Return = Risk-free Rate + beta * (Market Return - Risk-free Rate)
Expected Return = 5% + 1.40 * (9% - 5%)
Expected Return = 10.60%
Answer 5-b.
Amount Invested in Stock J = $80,000
Amount Invested in Stock K = $120,000
Total Value of Investment = Amount Invested in Stock J + Amount Invested in Stock K
Total Value of Investment = $80,000 + $120,000
Total Value of Investment = $200,000
Weight of Stock J = Amount Invested in Sock J / Total Value of Investment
Weight of Stock J = $80,000 / $200,000
Weight of Stock J = 0.40
Weight of Stock K = Amount Invested in Sock J / Total Value of Investment
Weight of Stock K = $120,000 / $200,000
Weight of Stock K = 0.60
Portfolio Return = Weight of Stock J * Expected Return of Stock J + Weight of Stock K * Expected Return of Stock K
Portfolio Return = 0.40 * 8.20% + 0.60 * 10.60%
Portfolio Return = 9.64%
Answer 5-c.
Current Dividend, D0 = $2.50
Growth rate, g = 7%
Expected Return, k = 10.60%
Next-year Dividend, D1 = D0 * (1+g)
Next-year Dividend, D1 = $2.50 * 1.07
Next-year Dividend, D1 = $2.675
Intrinsic Value, P0 = D1 / (k - g)
Intrinsic Value, P0 = $2.675 / (0.1060 - 0.07)
Intrinsic Value, P0 = $2.675 / 0.0360
Intrinsic Value, P0 = $74.31
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