Question: A stock that currently trades at $10 has a beta of 1.1. The risk-free interest rate for the coming year is 3 percent, and the market price of risk is 7 percent. (a) What should the expected return on the stock be? (b) If the stock price is not expected to increase this year (i.e., the stock price is expected to remain unchanged), what dividend payments must investors be expecting for the coming year? (c) Now assume that dividends over the coming year are expected to be $0.25 per share and the stock price at the end of this year is expected to be $12. Would you recommend the purchase of this stock to your investment clients? [Show your calculations and explain fully.]
Dividend Valuation
Dividend refers to a reward or cash that a company gives to its shareholders out of the profits. Dividends can be issued in various forms such as cash payment, stocks, or in any other form as per the company norms. It is usually a part of the profit that the company shares with its shareholders.
Dividend Discount Model
Dividend payments are generally paid to investors or shareholders of a company when the company earns profit for the year, thus representing growth. The dividend discount model is an important method used to forecast the price of a company’s stock. It is based on the computation methodology that the present value of all its future dividends is equivalent to the value of the company.
Capital Gains Yield
It may be referred to as the earnings generated on an investment over a particular period of time. It is generally expressed as a percentage and includes some dividends or interest earned by holding a particular security. Cases, where it is higher normally, indicate the higher income and lower risk. It is mostly computed on an annual basis and is different from the total return on investment. In case it becomes too high, indicates that either the stock prices are going down or the company is paying higher dividends.
Stock Valuation
In simple words, stock valuation is a tool to calculate the current price, or value, of a company. It is used to not only calculate the value of the company but help an investor decide if they want to buy, sell or hold a company's stocks.
Question:
A stock that currently trades at $10 has a beta of 1.1. The risk-free interest rate for the coming year is 3 percent, and the market price of risk is 7 percent.
(a) What should the expected return on the stock be?
(b) If the stock price is not expected to increase this year (i.e., the stock price is expected to remain unchanged), what dividend payments must investors be expecting for the coming year?
(c) Now assume that dividends over the coming year are expected to be $0.25 per share and the stock price at the end of this year is expected to be $12. Would you recommend the purchase of this stock to your investment clients? [Show your calculations and explain fully.]
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