Jen wants to assess the attractiveness of buying \'Made-It\'s\' stock, currently

Question

Jen wants to assess the attractiveness of buying 'Made-It's' stock, currently trading at $22.50 per share. Made-It executives claim that the company will have a constant growth rate of 9%, and that the dividend, paid at the end of the year, will be two dollars per share.

Jen has done some work with the Capital Asset Pricing Model.
She has determined that the Made-It's Beta is 2; that the risk-free rate is 1%, and that the S&P 500 is projected to grow at 10%.

Using CAPM, what is the required return on equity? and What is the expected total return on Made-It's stock?

!!! My question is Should Jen buy the stock? If not, what is the most that Jelena should pay for Made-It stock?

Explanation / Answer

using CAPM,

re = rf+(rm-rf)*

re = 1+(10-1)*2 = 19%

expected total return on Made-its stock = Div/P0 + g

= 2/22.5 + 0.09

= 17.89%

hence required rate of return of Jen which is 19% > expected rate of return on Made-its stock (17.89%)

hence Jen should not buy the stock

The most Jelena could pay for the stock = Div/(re-g)

= 2/(.19-.09)

= $20

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