Valuation

1. You are trying to estimate the stock price for Star Inc.

Risk-free rate= 2%

expected market return= 12%

SD of the market return= 40%

Star inc's covariance with the market= 40%.

Star inc pays dividends once a year just before the

new year.

(a) Assuming the CAPM holds, what is the expected return of Star Inc stock?

(b) Suppose that Star inc pays an expected annual dividend of $10 with zero growth. What is

the price of the stock?

(c) Suppose instead that Star inc pays an expected annual dividend of $4 with annual growth

rate of 10%. What is the price of the stock?

(d) An investor bought the stock of Star inc at the beginning of 2015 when expected dividend

was $10, just like in (b). In the beginning of 2016 the dividend unexpectedly changed

to $4 with 10% growth, like in (c). The investor sold the stock at the beginning of 2017.

What was the annualized HPR of this investment? The investor did not reinvest the

interim cash-

(e) Now suppose the beta of the stock increases. What does this do to the P/E ratio of the

stock? State the direction of the change, no calculations required.