A corporation has 12,000,000 shares of stock outstanding at a price of $40 per s

Question

A corporation has 12,000,000 shares of stock outstanding at a price of $40 per share. They just paid a dividend of $3 and the dividend is expected to grow by 4% per year forever. The stock has a beta of .9, the current risk free rate is 3%, and the market risk premium is 7%. The corporation also has 400,000 bonds outstanding with a price of $950 per bond. The bond has a coupon rate of 6% with semiannual interest payments, a face value of $1,000, and 13 years to go until maturity. The company plans on issuing new debt until they reach their target debt ratio of 70%. They expect their cost of debt to be 9% and their cost of equity to be 13% under this new capital structure. The tax rate is 40%

18. What is the CAPM required return on the corporation

Explanation / Answer

Answer:

18. CAPM required return = Risk free rate + Beta * market risk premium

= 3% + 0.9 *7% =9.3%

19. Expected return   = (Expected Dividend / Market Price ) + Growth rate

Expected Dividend = Current dividend * (1+ growth rate )

= $3 * (1+0.04) = $3.12

= [3.12 / $40] + 0.04

= 0.118

= 11.8%

20. Relevant yield on the company

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