Question

25. The Jackson Company has just paid a dividend of $3.00 per share on its common stock, and it expects this dividend to grow by 10 percent per year, indefinitely. The firm has a beta of 1.50; the risk-free rate is 10 percent; and the expected return on the market is 14 percent. The firm's investment bankers believe that new issues of common stock would have a flotation cost equal to 5 percent of the current market price. How much should an investor be willing to pay for this stock today?

Answer 1

Answer:

$55 per share

Explanation:

For this question, first we have to determine the required rate of return by applying the CAPM model. The formula is present below:

Expected rate of return = Risk-free rate of return + Beta × (Market rate of return - Risk-free rate of return)

= 10% + 1.5 × (14% - 10%)

= 10% + 1.5 × 4%

= 10% + 6%

= 16%

Now the stock price is

= Next year dividend ÷ (Required rate of return - growth rate)

where,  

For next year

= $3+ $3 × 10%

= $3 + 0.3

= 3.3

So, the value would equal to

= 3.3 ÷ (16% - 10%)

= $55 per share