UNIT3_IP_FM

From XYZ 's Stock information document

Beta 1 .64

Current annual dividend 0 .80

3-year dividend growth rate (g 8 .2

Industry

/E 23 .2

EPS 76 .28

XYZ 's required rate of return (ks ) is calculated by the formula :-

ks kRF (kM - kRF . But we know that (kM - kRF ) is in fact the market risk premium . So

ks 2 .87 (7 .5 1 .64

ks 15 .17 (required rate of return

Using the CGM to find the current stock price for XYZ , we find that p

Po D0 (1 g (ks - g ) where D0 is the current annual dividends 0 .8 (1 0 .082 (0 .1517-0 .082 12 .42

1 . Yes there are differences between the theoretical and the actual price of XYZ

2 . One of the reasons behind the difference is investors ' expectations If they expect the company to perform better in future , this may influence their demand for the shares of XYZ and thus the difference This is generally the difference in expected value of the company 's share price . The two formulas used CAPM and CGM overlook certain fundamental factors which if included might bridge the gap between the two share prices

3 . With an increased market risk , the new price becomes :-

ks 2 .87 (10 1 .64 19 .27

Po 0 .8 (1 0 .082 (0 .1927-0 .082 7 .81933

If we however use

/E to find the price , then :-

Price

/E EPS 15 .65 4 .87 76 .22

4...