Hard Hat Construction's stock is currently selling at an equilibrium price of $30 per share. The firm has been experiencing a 6 percent annual growth rate. Last year's earnings per share, E0, were $4.00, and the dividend payout ratio is 40 percent. The risk-free rate is 8 percent, and the market risk premium is 5 percent. If market risk (beta) increases by 50 percent, and all other factors remain constant, by how much will the stock price change? (Hint: Use four decimal places in your calculations.)
A) -$ 7.33
B) +$ 7.14
C) -$15.00
D) -$15.22
E) +$22.63

Question

Quizplus · Accepted Answer

The stock price change can be calculated using the Capital Asset Pricing Model (CAPM) and the Gordon Growth Model. First, calculate the original required rate of return using CAPM: r = risk-free rate + beta * market risk premium. Then, adjust beta by 50% and recalculate the required rate of return. Use the Gordon Growth Model to find the new stock price: P = D1 / (r - g), where D1 is the expected dividend next year. The change in stock price is the difference between the new and old stock prices. The correct calculation shows a decrease of approximately $7.33.

Hard Hat Construction's Stock Is Currently Selling at an Equilibrium