The risk-free rate is 8% and the expected return on the market is 16%. As an ana

Question

The risk-free rate is 8% and the expected return on the market is 16%. As an analyst, you are preparing a recommendation report on the following two stocks:

                                                                                        Stock S                                 Stock B

                Beta                                                                       0.85                                        1.35

                Expected dividend next year                             $1.10                                      $4.00

                Growth rate (g)                                                     8%                                          6%

                Current Price (p0)                                                $22                                         $30.77

Following up on question 9, assume you are asked to evaluate two more stocks, T and C. Stock T has a beta of 0.85 and is currently selling for $45. It is expected to pay a dividend of $1.25 and sell at the end of the year for $50. Stock. Stock C has a beta of 1.35 and is expected to pay no dividends. It is currently trading at $67 and will sell at the end of the year for $82. Which stock will you recommend? What should be the price of stocks T and C for it to be in equilibrium (“hold” recommendation).

Explanation / Answer

Expected return froms stock C = 82/67-1 =22.38%

Retursn from CAPM =8% + 0.85*(16%-8%) = 14.8%

Expected return froms stock T = 1.25/45 + 5/45 =13.88%

Return from CAPM = 8% + 1.35*(16%-8%) =18.8%

Stock C should be recommendd because it would generate alpha

For equialiibrium

For stock c = 82/(1.188) =69.02

For stock T =50/(1.148) = 43.75 but as we are receivind dividends already it shou

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