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The following information is given: The market risk premium is 07%
The following information is given: The market risk premium is 07%. The beta of Alkan stock has been estimated at 1.35. It expects to pay a dividend of $2.80 next year. The current price of the stock is $84. the expected price next year is $98What should be the risk-free rate today for you to recommend purchasing the stock?
Expert Solution
Computation of Required Rate of Return on Stock:
Required Rate of Return = (Expected Price Next Year+Expected Dividend Next Year)/Current Stock Price - 1
= ($2.80+$98)/$84 - 1
= $100.80/$84 - 1
= 1.20 - 1
Required Rate of Return = 0.20 or 20%
Now we calculate Risk-free Rate:
Required Rate of Return (using CAPM) = Risk-free Rate + Beta*Market Risk Premium
20% = Risk-free Rate + 1.35*7%
20% = Risk-free Rate + 9.45%
Risk-free Rate = 20% - 9.45% = 10.55%
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