Cache Creek Manufacturing Company is expected to pay a dividend of $3.36 in the upcoming year.Dividends are expected to grow at 8% per year.The riskfree rate of return is 4% and the expected return on the market portfolio is 14%.Investors use the CAPM to compute the market capitalization rate,and the constant growth DDM to determine the value of the stock.The stock's current price is $84.00.Using the constant growth DDM,the market capitalization rate is _________.

Question

Quizplus · Accepted Answer

To use the constant growth DDM formula, we need to calculate the required rate of return or market capitalization rate (R) first. 
R = Rf + β(Rm - Rf) 
where Rf = risk-free rate = 4%, Rm = expected return on the market portfolio = 14%, and β = beta of the stock, which is not given. 
Since we do not have beta, we cannot compute R using the CAPM. However, we can use the dividend growth model to find the implied market capitalization rate. 
Using the formula: 
P0 = D1 / (R - g) 
where P0 = current stock price = $84.00, D1 = next year's dividend = $3.36, and g = expected growth rate of dividends = 8%. 
Plugging in the values: 
$84.00 = $3.36 / (R - 8%) 
Solving for R, we get: 
R = 12% 
Therefore, the market capitalization rate implied by the constant growth DDM is 12%.

Cache Creek Manufacturing Company Is Expected to Pay a Dividend