Smart Investors, Inc., is expected to pay a dividend of $4.20 in the upcoming ye

Question

Smart Investors, Inc., is expected to pay a dividend of $4.20 in the upcoming year. Dividends are expected to grow at the rate of 8% per year. The riskless rate of return is 4% and the expected return on the market portfolio is 14%. Investors use the CAPM to compute the growth rate on the stock, and the constant growth DDM to determine the intrinsic value of the stock. The stock is trading in the market today at $84.00. Using the constant growth DDM and the CAPM, the beta of the stock is ___

(a) 1.4

(b) 0.9

(c) 0.8

(d) 0.5

Explanation / Answer

(b) 0.9

Beta = ( r - RFR )/( MR - RFR )

r = [ D(0)*(1+g)/P(0) ] + g = [ 4.2*1.08/84 ] + 0.08 = 0.134

Bets = ( 0.134 - 0.04)/( 0.14 - 0.04 ) = 0.9

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