Jackson 5 industries decided to pay a $4 dividend in one year and the stock is c
ID: 2755953 • Letter: J
Question
Jackson 5 industries decided to pay a $4 dividend in one year and the stock is currently trading at $22.18. The firm expects dividends to grow at 20% for the next three years it pays dividends. After that point in time, the firm anticipates that the dividend growth rate will lineraly decline over the next four years to a long term constant growth rate of 2.5%. The risk premium for market is currently 4% with the risk free rate of 1.25%. In general, Jackson 5 industries is considered to be about 25% more sensitive to systematic risk as proxied by the market than other firms. What is the required rate of return for jackson 5 industries? how much is one share worth today? should you buy, sell, or hold share? Why?
Explanation / Answer
Beta of the market is 1.
Beta of Jackson is 25% more of the beta of the market
Therefore, Beta of Jackson is 1.25
Required rate of return (ke) = Risk free rate + [Beta x Market Risk Premium]
= 1.25 + [1.25 x 4]
= 6.25%
Worth of share = Dividend expected next year / Ke - g
= [4 x 1.20] / (0.0625 - 0.025)
= $120
The share is selling at $22.18, that means it is underpriced in the market, it should be held.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.