Step 1:
Risk Free Rate = Rf = 4%
Return on Market = Rm = 12.75%
Beta = β = 1.6
Required rate of Return using CAPM formula = Rf + β (Rm - Rf)
= 4% + 1.6 (12.75% - 4%)
= 4% + 14%
= 18%
Required Rate of Return is 18%
Step 2:
Last Dividend = D0 = $1.5
Dividend in Year 1 = D1 = D0 * (1+g) = $1.5 * (1+20%) = $1.8
Dividend in Year 2 = D2 = D1 * (1+g) = $1.8 * (1+20%) = $2.16
Dividend in Year 3 = D3 = D2 * (1+g) = $2.16 * (1+20%) = $2.592
Dividend in Year 4 = D4 = D3 * (1+g) = $2.592 * (1+20%) = $3.1104
Dividend in Year 5 = D5 = D4 * (1+g) = $3.1104 * (1+0) = $3.1104
Value of Dividend at year 4 for years 5 to forever =H = D5 / Required rate of return = $3.1104 /18% = $17.28
Step 3:
Current Common Stock Price = Present value of all dividends
= [D1 / (1+r)^1] + [D2 / (1+r)^2] + [D3 / (1+r)^3] + [D4 / (1+r)^4] + [H / (1+r)^4]\
= [$1.8 / (1+18%)^1] + [$2.16 / (1+18%)^2] + [$2.592 / (1+18%)^3] +[$3.1104 / (1+18%)^1] + [$17.28 / (1+18%)^4]
= [$1.8 / 1.18] + [$2.16 / 1.3924] + [$2.592 / 1.643032] + [$3.1104 / 1.93877776] + [$17.28 / 1.93877776]
= $1.52542373 + $1.55127837 + $1.57757122 + $1.60430972 + $8.91283176
= $15.1714148
Therefore, Current Common Stock Price is $15.17
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