Find B has a beta of 1.5. The risk-free rate of return 1s premium is 6 percent.

Question

Find B has a beta of 1.5. The risk-free rate of return 1s premium is 6 percent. Find the required rate of return on capital). 5 percent and the market risk b) XYZ, Inc. will pay a dividend of $4.00 per share net next 5 yearar foreveta return on the stock (i.e., the cost of equity dividend payment by s0.50 a share every year for tnercent per tock fonm hereafter, the dividends are expected to grow atp year. The firm will incre the firm will increase the years (i.e ., XYZ's current stock value? Use the required rate of return ear forever. What is 5 per the stock from (a) return on the year forever t 6

Explanation / Answer

Requirement (a) – Required rate of return on the stock = 14%

As per Capital Asset Pricing Model [CAPM],

Cost of equity = Rf + [Beta x Risk Premium]

= 5% + [1.50 x 6%]

= 5% + 9%

= 14%

Requirement (b) – XYZ’s Current Stock Value = $75.83 per share

Dividend in Year 1 [D1] = $4.00 per share

Dividend in Year 2 [D2] = $4.50 per share

Dividend in Year 3 [D3] = $5.00 per share

Dividend in Year 4 [D4] = $5.50 per share

Dividend in Year 5 [D5] = $6.00 per share

Dividend in Year 6 [D6] = $6.50 per share

Current Stock Value = Dividend in Year 6[1+g] / [Ke – g]

= D6[1+g] / [Ke – g]

= [$6.50 x 1.05] / [0.14 – 0.05]

= $6.83 / 0.09

= $75.83 per share

**The answer you have calculated for the Requirement (a) as 6.50% is incorrect. The right formula to calculate the Required rate of return under Capital Asset Pricing Model [CAPM], is = Rf + [Beta x Risk Premium]

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