The board of directors of API, a relatively new electronics manufacturer, has de
ID: 2773445 • Letter: T
Question
The board of directors of API, a relatively new electronics manufacturer, has decided to begin paying a common stock dividend to increase the attractiveness of the stock in the free market. The board plans to pay $2.45 per share in the coming year (i.e., next year) and anticipates that its future dividends will increase at an annual rate consistent with that experienced over the period from 2009 - 2012 (see below). The company currently has a beta of 1.5, the rate of return for the market is expected to be 8% and the risk-free rate is currently 3%. Given this scenario, what is the current value of API's common stock? If the current market price is $48.00 per share, should you purchase this stock? Briefly, explain your answer. (HINT: This problem requires a three-part calculation to solve it). USE MS EXCEL TO CONDUCT YOUR CALCULATIONS (do NOT round your interim calculations, rather use links between the cells,) Please post excel spreadsheet
Year Dividend
2012 $2.32
2011 $2.21
2010 $2.10
2009 $2.00
Explanation / Answer
Answer:
Risk free rate + beta *(expected market - risk free)
3%+1.5*(8%-3%) = 10.50%
$ 42.74
No, the stock should not be purchased
Dividend growth 2009 2 2010 2.1 5.00% 2011 2.21 5.24% 2012 2.32 4.98% Average growth rate 5.07% Now, Calculating the rate of return using CAPM 10.50%Risk free rate + beta *(expected market - risk free)
3%+1.5*(8%-3%) = 10.50%
Current price of the stock = D1 / (r-g) = 2.32/(10.5%-5.07%) =$ 42.74
No, the stock should not be purchased
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