Q3. Stock Valuation and Risk

a. Suppose you know that a company just paid a dividend of $1.75 per share on tis stock and that the dividend will continue to grow at a rate of 8 percent per year. If the required return on this stock is 10 percent, what is the current share price?

b. A stock has a beta of 2.2, the risk-free rate is 6 percent, and the expected return on the market is 12 percent. Using CAMP, what would you expect the required rate of return on this stock to be? What is the market risk premium?

c. Assume that you are very confident that the stock market will perform well in the near future. Recently, one of your friends recommended a stock of a specific firm to you because the firm had performed very well in the past few years, the firm has a low beta (i.e., a low degree of systematic risk), and its beta is expected to remain low. You usually rely on beta as a measurement of a firms systematic risk. If you are thinking about selecting a specific stock that will perform well in response to an expected runup in the stock market, should you seriously consider buying that stock? Why?

d. According to the CAMP, stock prices may decrease in response to a higher risk-free rate, explain why. However, in some periods, we would observe that the stock prices may increase even though the risk-free rates increase, explain why the reason. (hint: risk-free rate usually rises when the economic conditions are strong).