Question: The price of a stock is dependent on the return and risk. Derive the p

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Question:

The price of a stock is dependent on the return and risk. Derive the price if the risk premium is 10%, the beta is 1.7, the net profit margin is 12%, the asset turnover is 1.6, the leverage ratio is 1.2 and the retention ratio is 80%. While the D0 (Dividend Zero) is $5. Afterward, the bheta becomes 2, while the net profit margin, asset turnover and leverage ratio is .08, 1 and 1.2 and retention ratio is 90%.

Note: My professor added that the risk free rate or default risk rate is 4%

The problem was already solved, with the added risk free rate of 4%. I am hoping if someone can check if the approach and answer is correct and maybe expand more on the previous work shown. Please show your work (step by step) and explain throughly. The more work you show and the more clearly your explanation is, the better for me because it helps me understand how you arrived at your solution and explain the problem to my professor. This question is important to me because I need it for a take home exam. I would appreciate any help that I can get. Thanks in advance.

Required rate of return = Rf + Beta x Risk premium

= 4 + 1.7 x 10

= 21%

g = b x r

= 12 x 80%

= 9.60%

Price of stock = D0(1+g) / (Ke-g)

= 5(1+0.096) / (0.21 - 0.096)

= $48.07

Explanation / Answer

Required rate of return under capital asset pricing method (CAPM) = Rf + Beta x Risk premium = 4 + 1.7 x 10 = 0.21 grouth rate = return x retention ratio = 12 x 80% = 0.096 Price of stock = D0(1+g) / (Ke-g) = 5(1+0.096) / (0.21 - 0.096) = $48.07 when beta 2, net profit margin 8%, and retention ratio is 90% Required rate of return under capital asset pricing method (CAPM) = Rf + Beta x Risk premium = 4 + 2 x 10 = 0.24 grouth rate = return x retention ratio = 8 x 90% = 0.072 Price of stock = D0(1+g) / (Ke-g) = 5(1+0.072) / (0.24 - 0.072) = $31.90

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