Hampton Corporation's common stock dividends are expected to grow by 8% per year. Recently, the firm paid a $3.00 common stock dividend. Hampton has a beta of 1.40. The expected return on the S&P 500 index is 12.5% and the rate of return on U.S. Treasury securities is 7%. Using this information and the CAPM, what is the stock's intrinsic value?
a) $72
b) $66.67
c) $24
d) $48.36
e) $25.92

Question

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andromache andromache · Answer 1 · 2019-11-23T12:08:20+01:00

Answer:

d) $48.36

Explanation:

For computing the intrinsic value, first we have to compute the cost of equity by using CAPM Model which is shown below:

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

= 7% + 1.4 × (12.5% - 7%)

= 7% + 1.4 × 5.5%

= 7% + 7.7%

= 14.70%

Now the intrinsic value would be

In this question, we apply the Gordon model which is shown below:

= Next year dividend ÷ (Required rate of return - growth rate)

where,

Current year dividend

= $3 + $3 × 8%

= $3 + 0.24

= $3.24

The other items rate would remain the same

Now put these values to the above formula

So, the value would equal to

= 3.24 ÷ (14.70% - 8%)

= $48.36