a) An investor is holding 1,000 shares of Limited Company. Presently the rate of
ID: 2658482 • Letter: A
Question
a) An investor is holding 1,000 shares of Limited Company. Presently the rate of dividend being paid by company is 2 per share and the share is being sold at 25 per share in the market. However, several factors are likely to change during the course of the year as indicated below: Q.1. 18 Marks Existing i 5% Risk free rate Market risk premium Beta value Expected growth rate Revised 17% 4% 1.75 8% | 6% 1.60 6% In view of the above factors whether the investor should buy, hold or sell the shares? And why?Explanation / Answer
Particulars Existing Revised
Rate of return (refer note1) 24.6% 24%
Price of Share (refer note 2) 11.40 13.5
Market Price 25 25
Inference overpriced overpriced
Decision Sell Sell
Conclusion: Since shares are overpriced under both the situation the course of action for both the situation will be same i.e , the investor should sell those shares.
Notes:
1)Calculation of Rate of Return using CAPM Model
Rate of Return=Risk free rate+Beta(Risk premium)
Existing
Rate of return=0.15+1.60(0.06)*100
=24.6%
Revised
Rate of return=0.17+1.75(0.04)*100
=24%
2) Price of share
Existing
Po=Do(1+g)/Ke-g
Po=2*(1+0.06)/(0.246-0.06)
=2*(1.06)/0.186
=11.40
Revised
Po=2*(1+0.08)/(0.24-0.08)
=2*(1.08)/(0.16)
=13.5
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