Jersey Jewel Mining has a beta coefficient of 1.2. Currently therisk-free rate i

Question

Jersey Jewel Mining has a beta coefficient of 1.2. Currently therisk-free rate is 5 percent
and the anticipated return on the market is 11 percent. JJM pays a$4.50 dividend that is
growing at 6 percent annually.
a. What is the required return for JJM?
b. Given the required return, what is the value of the stock?
c. If the stock is selling for $80, what should you do?
d. If the beta coefficient declines to 1.0, what is the new valueof the stock?
e. If the price remains $80, what course of action should you takegiven the valuation in
(d)?

Explanation / Answer

Beta Coefficient (ß) = 1.2 Risk-free rate (Rf) =5% Return on the Market (RM) =11% Dividend paid (D0) =$4.50 Dividend growth rate (g) = 6%annually (a) Calculating Required Returnfor JJM (RE) According to CAPM, the Required Return(RE) = Rf + ß (RM -Rf) Required Return (RE) = 5% + 1.2 (11%- 5%) Required Return (RE) = 0.05 + 1.2(0.11 - 0.05) Required Return (RE) = 0.05 + 1.2 *0.06 Required Return (RE) = 0.122 (or)12.20% Required Return (RE) =12.2% (b) Calculating Stock Value(P0): Current StockValue (P0)   =   D1/ (R-g) Expected Dividend Payment for the nextyear (D1) = D0 (1+g) Expected Dividend Payment for the next year(D1) = $4.50 (1+0.06) Expected Dividend Payment for the next year(D1) = $4.77 Current Stock Value (P0) = $4.77 /(0.122 - 0.06) Current Stock Value (P0) =$4.77 / 0.062 Current Stock Valeu (P0)= $76.94 (c ) If the Stock is sellingfor $80, the Required Return for the Stock willbe: Current StockValue (P0)   =   D1/ (R-g) Required Return ( R) = [D1 /P0] + g Required Return (R ) = [$4.77 / $80] +0.06 Required Return (R ) = 0.1196 (or)11.96% (d) If the beta coefficientdeclines to 1.0, the new value of the stock willbe: According to CAPM, the Required Return(RE) = Rf + ß (RM -Rf) Beta coefficient (ß) = 1.0 Return on Market (RM) =11% Risk-free Rate (Rf) =5% RE = 5% + 1.0 (11% -5%) RE = 0.05 + 1.0 (0.06) RE = 0.05 + 0.06 Required Rate of Return (RE) = 0.11(or) 11%] Current StockValue (P0)   =   D1/ (R-g) New Stock Value (P0) = $4.77 /(0.11- 0.06) New Stock Value (P0) = $4.77 /0.05 New Stock Value (P0) =$95.40 Beta Coefficient (ß) = 1.2 Risk-free rate (Rf) =5% Return on the Market (RM) =11% Dividend paid (D0) =$4.50 Dividend growth rate (g) = 6%annually (a) Calculating Required Returnfor JJM (RE) According to CAPM, the Required Return(RE) = Rf + ß (RM -Rf) Required Return (RE) = 5% + 1.2 (11%- 5%) Required Return (RE) = 0.05 + 1.2(0.11 - 0.05) Required Return (RE) = 0.05 + 1.2 *0.06 Required Return (RE) = 0.122 (or)12.20% Required Return (RE) =12.2% (b) Calculating Stock Value(P0): Current StockValue (P0)   =   D1/ (R-g) Expected Dividend Payment for the nextyear (D1) = D0 (1+g) Expected Dividend Payment for the next year(D1) = $4.50 (1+0.06) Expected Dividend Payment for the next year(D1) = $4.77 Current Stock Value (P0) = $4.77 /(0.122 - 0.06) Current Stock Value (P0) =$4.77 / 0.062 Current Stock Valeu (P0)= $76.94 (c ) If the Stock is sellingfor $80, the Required Return for the Stock willbe: Current StockValue (P0)   =   D1/ (R-g) Required Return ( R) = [D1 /P0] + g Required Return (R ) = [$4.77 / $80] +0.06 Required Return (R ) = 0.1196 (or)11.96% (d) If the beta coefficientdeclines to 1.0, the new value of the stock willbe: According to CAPM, the Required Return(RE) = Rf + ß (RM -Rf) Beta coefficient (ß) = 1.0 Return on Market (RM) =11% Risk-free Rate (Rf) =5% RE = 5% + 1.0 (11% -5%) RE = 0.05 + 1.0 (0.06) RE = 0.05 + 0.06 Required Rate of Return (RE) = 0.11(or) 11%] Current StockValue (P0)   =   D1/ (R-g) New Stock Value (P0) = $4.77 /(0.11- 0.06) New Stock Value (P0) = $4.77 /0.05 New Stock Value (P0) =$95.40 Beta Coefficient (ß) = 1.2 Risk-free rate (Rf) =5% Return on the Market (RM) =11% Dividend paid (D0) =$4.50 Dividend growth rate (g) = 6%annually (a) Calculating Required Returnfor JJM (RE) According to CAPM, the Required Return(RE) = Rf + ß (RM -Rf) Required Return (RE) = 5% + 1.2 (11%- 5%) Required Return (RE) = 0.05 + 1.2(0.11 - 0.05) Required Return (RE) = 0.05 + 1.2 *0.06 Required Return (RE) = 0.122 (or)12.20% Required Return (RE) =12.2% (b) Calculating Stock Value(P0): Current StockValue (P0)   =   D1/ (R-g) Expected Dividend Payment for the nextyear (D1) = D0 (1+g) Expected Dividend Payment for the next year(D1) = $4.50 (1+0.06) Expected Dividend Payment for the next year(D1) = $4.77 Current Stock Value (P0) = $4.77 /(0.122 - 0.06) Current Stock Value (P0) =$4.77 / 0.062 Current Stock Valeu (P0)= $76.94 (c ) If the Stock is sellingfor $80, the Required Return for the Stock willbe: Current StockValue (P0)   =   D1/ (R-g) Required Return ( R) = [D1 /P0] + g Required Return (R ) = [$4.77 / $80] +0.06 Required Return (R ) = 0.1196 (or)11.96% (d) If the beta coefficientdeclines to 1.0, the new value of the stock willbe: According to CAPM, the Required Return(RE) = Rf + ß (RM -Rf) Beta coefficient (ß) = 1.0 Return on Market (RM) =11% Risk-free Rate (Rf) =5% RE = 5% + 1.0 (11% -5%) RE = 0.05 + 1.0 (0.06) RE = 0.05 + 0.06 Required Rate of Return (RE) = 0.11(or) 11%] Current StockValue (P0)   =   D1/ (R-g) New Stock Value (P0) = $4.77 /(0.11- 0.06) New Stock Value (P0) = $4.77 /0.05 New Stock Value (P0) =$95.40

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