BC Corporation has just paid a dividend of $2.20 per share on its common shares.Its dividend is expected to grow at a rate of 5% per year indefinitely.The current share price is $30 and the risk premium associated with this share is 8.7%.What is the implied risk-free rate?

Question

Quizplus · Accepted Answer

We can use the dividend discount model to find the implied risk-free rate.

First, we need to calculate the expected dividend for next year:
Expected Dividend = Current Dividend x (1 + Dividend Growth Rate)
Expected Dividend = $2.20 x (1 + 5%) = $2.31

Next, we can use the dividend discount model formula:
Share Price = Expected Dividend / (Discount Rate - Dividend Growth Rate)

We are given the share price and dividend growth rate, and we can use the risk premium as the discount rate:
$30 = $2.31 / (0.087 - 0.05)

Solving for the discount rate (which includes the risk-free rate):
Discount Rate = 0.117
Risk-Free Rate = Discount Rate - Risk Premium
Risk-Free Rate = 0.117 - 0.087 = 0.03 or 3.00%

Therefore, the best choice is C, with an implied risk-free rate of 4.00%.

BC Corporation Has Just Paid a Dividend of $2