Jersey Jewel Mining has a beta coofficient of 1.2. Currently the risk-free rate

Question

Jersey Jewel Mining has a beta coofficient of 1.2. Currently the risk-free rate is 2 percent and the anticipated return on the market is 8 percent. JJM pays a $4.50 dividend that is growing at 4 percent annually.

a. What is the required return for JJM?

b. Given the required return, what is the value of the stock?

c. If the stock is selling for $100, what should you do?

d. If the beta coefficient declines to 1.0, what is the new value of the stock?

e. If the price remains $100, what course of action should you take given the valuation in d?

Explanation / Answer

a)

Required return using CAPM = risk free rate + beta ( expected return on market - risk free rate)

Required return = 0.02 + 1.2 ( 0.08 - 0.02)

Required return = 0.092 or 9.2%

b)

Dividend in year 1 = 4.5 * 1.04 = 4.68

Value of stock = D1 / K - G

Value of stock = 4.68 / 0.092 - 0.04

Value of stock = 4.68 / 0.052

Value of stock = $90

c)

If the stock is selling for $100, you should sell the stock as the stock is overvalued

d)

Required return = 0.02 + 1 ( 0.08 - 0.02)

Required return = 0.08 or 8%

Value of stock = 4.68 / 0.08 - 0.04

Value of stock = 4.68 / 0.04

Value of stock = $117

e)

You should buy the stock if the price remians $100 as the stock is undervalued.

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