Suppose LlanoRiverFloaters Corporation stock just paid a one-time special divide

Question

Suppose LlanoRiverFloaters Corporation stock just paid a one-time special dividend of $20 to distribute some excess cash. Future dividends are expected to be back to normal, with dividends paid once-annually, with an expected dividend of $3.35 next year and every year thereafter (no growth). What is the price of the stock today if the company’s asset beta is 1.2, the company is half-equity and half-debt, and there are no taxes? Assume the expected market return is 11% and treasury bonds have yields of 3%.

Explanation / Answer

asset beta=0.5*equity beta+0.5*debt beta
as debt beta is 0 and no taxes
asset beta=0.5*equity beta
=>equity beta=2.4
CAPM says cost of equity=risk free+beta*(market return-risk free)=3%+2.4*(11%-3%)=22.2%

Price=3.35/cost of equity=3.35/22.2%=15.09009

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