a) For a company having a beta of 1.1, a current stock of $40 per share, and an

Question

a) For a company having a beta of 1.1, a current stock of $40 per share, and an expected dividend this coming year of $2.80 per share, what is projected stock price one year from today? (Find P1). Assume the market risk premium is 12% and the risk free rate is 6%.

b) A company is considering an investment that offers a net cash flow of $100,000 per year for the indefinite future. The risk of this project is felt to be the same as the average for all stocks i.e. beta=1. If the treasury bill rate is 8% and the market reture in expected to be 14%, what is the maximum investment outlay that should be made?

Explanation / Answer

(a) Adjusted cost of capital (Ke) = Risk free rate + Beta (Market Rate - Risk free rate)

Ke = 6% + 1.1 (12%-6%)

Ke = 12.6%

P0 = (Divident + P1) / 1 + Cost of capital

40 = (2.8 + P1) / 1.126

P1 = $42.24

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