Question 1, A company will pay $2 dividends next year. These dividends are expected to grow at a rate of 15% for four years. Afterwards, the long term growth rate is expected to settle at 4%. The published beta for the stock is 1.2, the expected rate of return on the market is 13% and the current risk free rate is 3%.
- Calculate the company’s dividends to from year 1 to year 5?
- MVI’s beta is 1.6, the expected return on the market is currently 12.75 percent, and the risk free rate is 4%? What should be the company’s required return?
- Calculate the company’s stock price at the end of year 4 as the constant growth period begins.
- Calculate the company’s stock price today.
Question 2, Given the following:
| State of the economy | Probability | End of Period Return | |
| Stock A | Stock B | ||
| good | 0.3 | 20% | 21% |
| average | 0.5 | 16% | 15% |
| bad | 0.2 | 11% | 7% |
- What are the expected return and standard deviation of the returns on stocks A and B?
- What is the expected return and standard deviation of a portfolio of 20% in A and 80% in B?
- What is the expected return and standard deviation of a portfolio with 80% in A and 20% in B?
- Which one of the two portfolios should be selected by a risk averse investor? Why?
SAMPLE SOLUTION :
Given that
Expected dividendv(D1) $2
Growth rate for 4 years (g1) 15%
Constant growth rate (g) 4%
Beta (β) 1.2
Expected return of market (Rm) 13%
Risk free rate (Rf) 3%
a) Dividend for year 1 D1*(1+g1) 2.3
Dividend for year 2 2.645
Dividend for year 3 3.04175
Dividend for year 4 3.4980125
Dividend for year 5 4.022714375
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