A common stock currently has a beta of 1

Finance Sep 10, 2020

A common stock currently has a beta of 1.3, the risk-free rate is an annual rate of 6 percent, and the market return is an annual rate of 12 percent. The stock is expected to generate a constant dividend of $5.20 per share. A toxic spill results in a lawsuit and potential fines, and the beta of the stock jumps to 1.6. The new equilibrium price of the stock is?

Expert Solution

Equilibrium price of the stock = per-share benefits / required rate of return

=$5.20 / 15.6%

= $33.33

working:

Expected rate or return = Risk free rate + Beta *(Market rate - Risk free rate )

= 6% + 1.6 * (12%-6%)

= 6% + 1.6*6%

= 15.6%

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