Question

Option #2: Personal Finance Application

Stock Valuation

• Use the information provided to calculate the required rate of return on four stocks. Use both CAPM and the Dividend Discount Model. The market return is expected to be 8.5% and the risk-free rate is 2.0%.

	Smith Company, Inc.	Competitor 1	Competitor 2	Competitor 3
Beta	1.4	1.7	1.2	0.9
Dividend	$2.00	$3.25	$2.00	$1.25
Price	$26.00	$33.00	$45.00	$20.00
Growth	3.5%	3.5%	5.5%	1.5%

Answer 1

Smith Company Inc.
Using CAPM Required Rate =Risk free rate+Beta*(Expected Return -Risk free Rate) =2%+1.4*(8.5%-2%) =11.10%
Using Dividend Discount Rate =Dividend*(1+growth)/Price +Growth) =2*(1+3.5%)/26+3.5% =11.4615% or 11.46%

Competitor 1
Using CAPM Required Rate =Risk free rate+Beta*(Expected Return -Risk free Rate) =2%+1.7*(8.5%-2%) =13.05%
Using Dividend Discount Rate =Dividend*(1+growth)/Price +Growth) =3.25*(1+3.5%)/33+3.5% =13.69%

Competitor 2
Using CAPM Required Rate =Risk free rate+Beta*(Expected Return -Risk free Rate) =2%+1.2*(8.5%-2%) =9.80%
Using Dividend Discount Rate =Dividend*(1+growth)/Price +Growth) =2*(1+5.5%)/45+5.5% =10.19%

Competitor 3
Using CAPM Required Rate =Risk free rate+Beta*(Expected Return -Risk free Rate) =2%+0.9*(8.5%-2%) =7.85%
Using Dividend Discount Rate =Dividend*(1+growth)/Price +Growth) =1.25*(1+1.5%)/20+1.5% =7.84%