Question 2

Company ABCs stock is currently priced at $100. It pays an annual dividend of $2.00. If you purchase the stock today at that price, answer the following.

1. What is your annualized return if in 4 years you sell the stock at $120? Ignore taxes.

If the Beta of ABC is 2.0, the risk-free rate is 3%, what is the required rate of return if the market risk premium is 6.0%? Would ABC be overvalued or undervalued if you expect the stock price (which is currently at $100) to be $115 in 1 year. Explain and quantify!

2. According to CAPM an increase in interest rates and/or an increase in the market risk premium will have what effect on required rates of return? How will these new required rates of return impact stock prices?