Problem 10-29 Required Return (LG10-3, LG10-7) You have assigned the following v

Question

Problem 10-29 Required Return (LG10-3, LG10-7) You have assigned the following values to these three firms: Price Upcoming Dividend Growth Beta US Bancorp $ 42.60 $ 2.40 9.60 % 1.74 Praxair 80.85 1.15 13.00 3.01 Eastman Kodak 26.50 2.00 12.50 1.11 Assume that the market portfolio will earn 9.00 percent and the risk-free rate is 2.20 percent. Compute the required return for each company using both CAPM and the constant-growth model. (Do not round intermediate calculations and round your final answers to 2 decimal places.)

Explanation / Answer

Market return = 9%

risk free = 2.2%

risk premium = 9% - 2.2% = 6.8%

CAPM model

Expected return E(r) = risk free + beta * risk premium

constant growth model

P = D1 / (r-g)

r = (D1 / P) + g

1)

US Bancorp

Price = 42.60 , Dividend(D1) = 2.40 , Growth rate(g) = 9.60%, beta = 1.74

CAPM

E(r) = 2.2% + 1.74*6.8% = 14.03%

constant growth

E(r) = ( 2.4/ 42.6 ) + 9.6% = 15.23%

2)

Praxair

Price = 80.85 , Dividend(D1) = 1.15, Growth rate(g) = 13%, beta = 3.01

CAPM

E(r) = 2.2% + 3.01*6.8% = 22.67%

constant growth

E(r) = ( 1.15 / 80.85 ) + 13% = 14.42%

3)

Eastman Kodak

Price = 26.5, Dividend(D1) = 2.0, Growth rate(g) = 12.5%, beta = 1.11

CAPM

E(r) = 2.2% + 1.11*6.8% = 9.75%

constant growth

E(r) = ( 2 / 26.5 ) + 12.5% = 20.05%

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