Atlantic Fishing Ltd.common shares have just paid a dividend of $1.80 per share and are selling for $34.48 each.The firm expects its dividend to grow at a constant rate of 6.3% each year.What is the risk premium associated with the share if the risk-free rate is 4.25 %?

Question

Quizplus · Accepted Answer

To calculate the required rate of return (RRR) for Atlantic Fishing Ltd common shares, we can use the dividend discount model:
RRR = (D1 / P0) + g
where D1 is the expected dividend next year, P0 is the current share price, and g is the expected annual growth rate of the dividend.

D1 = 1.80 x (1 + 0.063) = $1.9174
P0 = $34.48
g = 6.3%

RRR = (1.9174 / 34.48) + 0.063 = 0.1185 or 11.85%

The risk premium is equal to the required rate of return (RRR) minus the risk-free rate.

Risk premium = RRR - risk-free rate
Risk premium = 11.85% - 4.25% = 7.60%

Therefore, the answer is B (7.60%).