The stock of the Delta Corporation has a beta of 1.9. The stock recently paid an annual dividend of $1.60, and dividends are expected to grow at a rate of 10% indefinitely. The equity
Premium has averaged 8% in recent years, and it is expected to remain at this level for the
Foreseeable future. The relevant risk-free rate is 5%. What is the maximum price you should
Pay for a share of the Delta Corporation, according to CAPM?
A)$32.00
B)$15.69
C)$17.25
D)none of the above

Question

Quizplus · Accepted Answer

First, we need to calculate the required rate of return using the CAPM formula:

Required rate of return = Risk-free rate + (Beta * Equity premium)
Required rate of return = 5% + (1.9 * 8%) = 21.2%

Next, we can use the dividend discount model to calculate the maximum price we should pay for the stock:

Maximum price = Dividend / (Required rate of return - Dividend growth rate)
Maximum price = $1.60 / (21.2% - 10%) = $17.25

Therefore, the maximum price we should pay for a share of Delta Corporation according to CAPM is $17.25. Choice C is the correct answer.

The Stock of the Delta Corporation Has a Beta of 1.9