Question

Melissa is trying to value the stock of Generic Utility Inc., which is clearly not growing at all. Generic declared and paid a $5 dividend last year. The required rate of return for utility stock is 11%, but Melissa is unsure about the financial reporting integrity of Generic's finance team. She decides to add an extra 1% "credibility" risk premium to the required return as part of her valuation analysis.

a. What is the value of Generic's stock, assuming that the financials are trustworthy?

b. What is the value of Generic's stock, assuming that Melissa includes the extra 1% "credibility" risk premium?

c. What is the difference between the values found in parts a and b, and how might one interpret that difference?