Precious stone Jays Coropration pays a $0.75 quarterly profit with steady develo

Question

Precious stone Jays Coropration pays a $0.75 quarterly profit with steady development of 3.0% for every year and the stock at present offers for $30 for every offer (no obligation). The stock beta is 1.30; the business sector return Rm is 11%; the RISK free rate Rf is 3.0%. PLEASE SHOW HOW YOU ARRIVED AT ANSWER.

- Figure expense of capital utilizing the CAPM

- Figure expense of capital utilizing the dividend discount model

- What is the Equity Risk Premium? (variables and particular %)

- What suspicion about risk and return does the coefficient Beta suggest?

Explanation / Answer

Capital Asset Pricing Model

Cost of Capital = Riskfree Rate + [Beta (Market Rate of Return - Riskfree Rate)]

Cost of Capital = .03 + [ 1.3( .11 - .03)]

= 13.4%

Dividend Discount Model

Cost of Capital = ( 1 yr Forecasted Annual Dividend / Current Stock Price) + Dividend Growth Rate

Cost of Capital = ($.75 / $30) + .03%

=5.5%

Equity Market Risk Premium

EMRP = Return on Market% - Riskfree Rate%

EMRP= 11% - 3%

= 8%

Equity Risk Premium

ERP = Return on Stock% - Riskfree Rate%

ERP= 13.4% - 3%

= 10.4%

Beta = 1.3

Equity Risk Premium / Equity Market Risk Premium = Beta

10.4% / 8% = 1.3

Beta Coefficient

The Beta of 1.3 suggests that the risk and return would be greater than the market (benchmark) which has a Beta of 1. Simply put if your stocks Beta is over 1 your stock is more risky than the market and if it is under 1 it is less risky than the market.

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