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5
5. The probability distribution for kM for the coming year is as follows:
Probability kM
0.05 7%
0.30 8
0.30 9
0.30 10
0.05 12
If kRF = 6.05% and Stock X has a beta of 2.0, an expected constant growth rate of 7 percent, and D0 = $2, what market price gives the investor a return consistent with the stock's risk?
a. $25.00
b. $37.50
c. $21.72
d. $42.38
e. $56.94
Expert Solution
Expected value of market return = 0.05*7%+0.30*8%+0.30*9%+0.30*10%+0.05*12%
=0.0905 or 9.05%
Return in stock = KRf+beta*(Km-KRf) = 6.05+2*(9.05%-6.05%)=12.05%
Price =D1/(Kr-g) = 2*(1+7%)/(12.05%-7%)
=42.38
Answer is D.
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