Problem 11-06

The risk-free rate of return is 2 percent, and the expected return on the market is 6.9 percent. Stock A has a beta coefficient of 1.4, an earnings and dividend growth rate of 6 percent, and a current dividend of $3.40 a share. Do not round intermediate calculations. Round your answers to the nearest cent.

1. What should be the market price of the stock?

$............

b. If the current market price of the stock is $146.00, what should you do?

The stock (should / should not) be purchased.

c. If the expected return on the market rises to 11.2 percent and the other variables remain constant, what will be the value of the stock?

$................

d. If the risk-free return rises to 3 percent and the return on the market rises to 11.4 percent, what will be the value of the stock?

$................

e. If the beta coefficient falls to 1.2 and the other variables remain constant, what will be the value of the stock?

$................

f. Explain why the stocks value changes in c through e.

The increase in the return on the market (increases / decreases) the required return and (increases / decreases) the value of the stock.

The increase in the risk-free rate and the simultaneous increase in the return on the market cause the value of the stock to (increase / decrease) .

The decrease in the beta coefficient causes the firm to become (less / more) risky as measured by beta, which (increases / decreases) the value of the stock.