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Question 4: Answer the following questions: (10 Marks) 1
Question 4: Answer the following questions: (10 Marks)
1. Sara Corporation just paid a dividend of D0 = $0.75 per share, and that dividend is expected to grow at a constant rate of 6.50% per year in the future. The company's beta is 1.25, the required return on the market is 10.50%, and the risk-free rate is 4.50%. What is the company's current stock price? (6 Marks)
Answer:
Sandy Corp believes the following probability distribution exists for its stock. What is the coefficient of variation on the company's stock?
Probability Stock's State of of State Expected the Economy Occurring Return Boom 0.45 25% Normal 030 15% Recession 0.05 5%
Expert Solution
1) Computation of Company's Current Stock Price:
Stock price = Dividend for Next Period / (Equity Cost of Capital - Growth rate)
Here,
Equity Cost of Capital as per CAPM = Risk-Free rate + Beta*( Market Return - Risk-Free Rate)
= 4.5% + 1.25* (10.50% - 4.50%)
= 4.5% + 1.25*(6%)
= 4.5% + 7.5%
= 12%
Dividend for the Next Period = D0*( 1 + r)
= 0.75*( 1 + 6.5%)
= 0.79875
Stock price = 0.79875 / (0.12 - 0.065) = 14.522
So, The company's Current Stock Price is $14.522
2) Computation of Coefficient of Variation on the Company's Stock:
Expected Return=0.45*25%+0.5*15%+0.05*5% = 19%
Variance = 0.45*(25%-19%)^2+0.5*(15%-19%)^2+0.05*(5%-19%)^2
= 0.1620% + 0.08% + 0.098%
Variance = 0.34%
Standard Deviation=√ (Variance) =√(0.34%) = 0.05830951895
Coefficient of Variation= [Standard Deviation/Mean]*100
=0.05830951895/19% * 100
=0.306892205 * 100
Coefficient of Variation =30.69%
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