Question
You are contemplating an investment in the stock of Idol Corporation. You know that the price of Idol stock is estimated using the constant-growth dividend
You are contemplating an investment in the stock of Idol Corporation. You know that the price of Idol stock is estimated using the constant-growth dividend discount model and its required return (cost of equity) is estimated using the CAPM.
Yesterday, Idol paid a dividend of $3.00 per share. The dividend is expected to grow at an annual rate of 4% throughout the foreseeable future. Idols trailing P/E ratio is 18 and its debt/equity ratio is 1.25. The yield to maturity (cost of debt) for the bonds of Idol Corporation is 8% (which represents a 500 basis point spread over the risk-free rate). You also know that the expected market return (S&P 500) is 11%, with a standard deviation of 14%. The beta for Idol is 1.04, the correlation between Idol and the risk-free rate is .49, and Idols debt is rated BBB+.
Calculate the price per share of the Idol Corporation stock.
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