Fundamentals of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
9th Edition
ISBN: 9781259722615
Author: Richard A Brealey, Stewart C Myers, Alan J. Marcus Professor
Publisher: McGraw-Hill Education
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Chapter 11, Problem 5QP
Risk Premiums and Discount Rates. Top hedge fund manager Sally Buffit believes that a stock with the same market risk as the S&P 500 will sell at year-end at a price of $50. The stock will pay a dividend at year-end of $2. What price should she be willing to pay for the stock today? Assume that risk-free Treasury securities currently offer an interest rate of 2%. Use Table 11.1 to find a reasonable discount rate.
TABLE 11.1
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Top hedge fund manager Sally Buffit believes that a stock with the same market risk as the S&P 500 will sell at year-end at a price of $49. The stock will pay a divided at year-end of $3.00. Assume that risk-free Treasury securities currently offer an interest rate of 2.1%
Average rates of return on Treasury bills, government bonds, and common stocks, 1900-2017 (figures in percent per year) are as follows
Portfolio
Average Annual Rate of Return (%)
Average Premium (Extra return versus Treasury bills) (%)
Treasury bills
3.8
Treasury bonds
5.3
1.5
Common stocks
11.5
7.7
What is the discount rate on the Stock?
7.7%+ 2.1% =9.8%
What price should she be willing to pay for the stock today?
Price= ($3.00 + $49)/ (1+0.098) = $47.36
Top hedge fund manager Sally Buffit believes that a stock with the same market risk as the S&P 500 will sell at year-end at a price of $50. The stock will
pay a dividend at year-end of $2. Assume that risk-free Treasury securities currently offer an interest rate of 2%.
Average rates of return on Treasury bills, government bonds, and common stocks, 1900-2017 (figures in percent per year) are as follows.
Average Premium
(Extra return
versus Treasury
bills) ($)
Average Annual
Rate of Return
ipped
Portfolio
($)
3.8
Treasury bills
Treasury bonds
5.3
1.5
Common stocks
11.5
7.7
Book
Ask
a. What is the discount rate on the stock? (Enter your answer as a percent rounded to 2 decimal places.)
Print
eferences
Discount rate
9.70 %
b. What price should she be willing to pay for the stock today? (Do not round intermediate calculations. Round your answer
decimal places.)
Stock price
Top hedge fund manager Sally Buffit believes that a stock with the same market risk as the S&P 500 will sell at year-end
at a price of $50. The stock will pay a dividend at year-end of $2. Assume that risk-free Treasury securities currently
offer an interest rate of 2%.
Average rates of return on Treasury bills, government bonds, and common stocks, 1900-2017 (figures in percent per
year) are as follows.
Average Premium
(Extra return
veraus Treasury
bills) ()
Average Annual
Rate of Return
Portfolio
Treasury billa
Treasury bonda
Common atocks
(%)
3.8
5.3
11.5
1.5
7.7
a. What is the discount rate on the stock? (Enter your answer as a percent rounded to 2 decimal places.)
Discount rate
%
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Fundamentals of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
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