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30 September, 18:10

A company just paid a dividend of $2 per share, and that dividend is expected to grow at a constant rate of 3% per year in the future. The company's beta is 2, the expected return on the market is 8% and the risk-free rate is 3%. What is the company's current stock price?

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  1. 30 September, 18:35
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    Current dividend (Do) = $2

    Growth rate (g) = 3% = 0.03

    Beta (β) = 2

    Risk free rate (Rf) = 3%

    Market return (Rm) = 8%

    Ke = Rf + β (Rm - Rf)

    Ke = 3 + 2 (8 - 2)

    Ke = 3 + 12

    Ke = 15%

    Po = Do (1 + g)

    Ke - g

    Po = $2 (1 + 0.03)

    0.15 - 0.03

    Po = $2.06/0.12

    Po = $17.17

    Explanation:

    In this case, we will calculate cost of equity based on capital asset pricing model. Then, we will calculate the current stock price. The current stock price is a function of current dividend paid subject to growth rate divided by the diffrence between cost of equity and growth rate.
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