. Pedro has a beta of 1.5 and the current Treasury Bond rate is 4 percent with t
ID: 2759433 • Letter: #
Question
. Pedro has a beta of 1.5 and the current Treasury Bond rate is 4 percent with the market required rate of return of 12 percent.
Pedro's common stock has a required rate of return of
a. 17% B. 16% C. 24% D. 12%
The market risk premium is
a. 12% b. 5% c. 8% d. none.
Pedro past dividend payments were:
YEAR DIVIDEND
2002 2.00
2003 2.12
2004 2.25
2005 2.30
2006 2.53
2007 2.68
Pedro’s stock should sell for $_________________
Draw the SML given the information from Pedro and properly label the axis and the points, label the line SML1.
Draw a second SML on the same graph that would show an increase in the T-Bond rate by 2% and label it SML2.
Explanation / Answer
Beta (B)
1.5
Treasury Bond Rate (Risk Free) i.e. Rf
4%
Market Rate i.e. Rm
12%
a)
Required Rate of return (as per CAPM Model) :
Rf + B*(Rm - Rf)
=
16%
b)
Market Risk Premium = Market Rate - Risk Free Rate
Market Risk Premium = 8%
c)
Pedro,s Stock Price
Year
Dividend
Discount Factor @ 16 %
PV
2002
2.00
0.862
1.72
2003
2.12
0.743
1.58
2004
2.25
0.641
1.44
2005
2.30
0.552
1.27
2006
2.53
0.476
1.20
2007
2.68
0.410
1.10
Stock Price
8.32
d)
SML Reflects the relationship between CAPM Retun and BETA
Beta = 1.5
CAPM = 16 %
Risk Free Rate = 4 %
If Treasury Bond rate is incresed by 2 % then
Beta = 1.5
CAPM = 16 %
Risk Free Rate = 6 %
Beta (B)
1.5
Treasury Bond Rate (Risk Free) i.e. Rf
4%
Market Rate i.e. Rm
12%
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.