The following information is available in general and about investments in stock
ID: 2675859 • Letter: T
Question
The following information is available in general and about investments in stocks J and K.The market return (kM) = 9%
The risk free rate (kRF) = 5%
Stock J's beta = 0.8
Expected constant growth rate for Stock J = 6%
Investment in Stock J = $80,000
Stock K's beta = 1.4
Expected constant growth rate for Stock K = 7%
Investment in Stock K = $120,000
a. What are the expected returns on Stock J and Stock K individually?
b. What is the expected return on the portfolio?
c. If Stock K just paid a dividend of $2.50, what is Stock K's intrinsic value?
Explanation / Answer
(a)expected return stock j=risk free rate+beta(market return-risk free rate) 0.05+0.8(0.09-0.05) 0.05+0.032=0.082 expected return=8.2% expected return stock k=risk free rate+beta(market return-risk free rate) 0.05+1.4(0.09-0.05) 0.05+0.056=0.106 expected return of k=10.6% (b)200000*x=80000*0.082+120000*0.106 200000x=6560+12720 200000x=19280 x=19280/200000*100=9.64% (c)current dividend=2.5(1+0.07)=2.675 expected return=(dividend/price)+growth rate 0.106=(2.675/x)+0.07 0.106-0.07=2.675/x 0.036=2.675/x x=2.675/0.036 x=74.31 intrinsic price=74.31
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