Question

Stock X has a beta value of 1. It pays annual dividends, of $5, starting one year from today. If the risk-free return is currently 2%, and the equity risk premium is 5%, what is the present value of the stock?

Answer 1

$71.43%

Step-by-step explanation:

In this question, we apply the Capital Asset Pricing Model (CAPM) formula which is shown below

Cost of equity = Risk-free rate of return + Beta × (Market rate of return - Risk-free rate of return)

The (Market rate of return - Risk-free rate of return) is also known as equity risk premium

For computing the present value of the stock, first we have to compute the cost of equity which is shown below:

= 2% + 5 1 5%

= 2% + 5%

= 7%

Now the present value of the stock would be

= Annual dividend ÷ cost of equity

= $5 ÷ 7%

= $71.43%