9-12 Valuation of a constant growth stock Investors require a 15 percent rate of return on Levine Company's stock (that is, rs = 15%). a. What is its value if the previous dividend was Do = $2 and investors expect divi- dends to grow at a constant annual rate of (1) 5 percent, (2) O percent, (3) 5 per- cent, or (4) 10 percent? b. Using data from part a, what would the Gordon (constant growth) model value be if the required rate of return were 15 percent and the expected growth rate were (1) 15 percent or (2) 20 percent? Are these reasonable results? Explain. C. Is it reasonable to think that a constant growth stock could have g> rs? Rates of return and equilibrium Stock C's beta coefficient is bc = 0.4, while Stock D's is bp = -0.5. (Stock D's beta is negative, indicating that its return rises when returns on most other stocks fall. There are very few negative beta stocks, although collection agency stocks are sometimes cited as an example.) a. If the risk-free rate is 7 percent and the expected rate of return on an average stock is 11 percent, what are the required rates of return on Stocks C and D? b. For Stock C, suppose the current price, Po, is $25; the next expected dividend, D,, is $1.50; and the stock's expected constant growth rate is 4 percent. Is the stock in equi- librium? Explain, and describe what would happen if the stock is not in equilibrium. 9-13