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Business and Public management

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%.

  1. Calculate the company’s dividends to from year 1 to year 5?
  2.  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?
  3.  Calculate the company’s stock price at the end of year 4 as the constant growth period begins.
  4. 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%
  1. What are the expected return and standard deviation of the returns on stocks A and B?
  2. What is the expected return and standard deviation of a portfolio of 20% in A and 80% in B?
  3. What is the expected return and standard deviation of a portfolio with 80% in A and 20% in B?
  4. 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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