Gates Industries' current common stock dividend (year 0) is $2.50 per share and is expected to continue growing at a rate of 5% per year for the foreseeable future. Currently the risk-free rate is 7.5% and the estimated market risk premium (i.e., k_m - r_f) is 8.3%. Value Line has estimated Gates Industries' beta to be 1.10. Determine the expected price for Gates Industries, common stock. A) $21.50 B) $15.03 C) $15.78 D) $22.57

Question

Quizplus · Accepted Answer

To determine the expected price of Gates Industries' common stock, we first calculate the required rate of return using the Capital Asset Pricing Model (CAPM): Required return = Risk-free rate + (Beta * Market risk premium) = 7.5% + (1.10 * 8.3%) = 7.5% + 9.13% = 16.63%. Then, we use the Gordon Growth Model to find the stock price: Price = Dividend next year / (Required return - Growth rate) = $2.50 * (1 + 5%) / (16.63% - 5%) = $2.625 / 11.63% = $22.57.

Gates Industries' Current Common Stock Dividend (Year 0) Is $2