Corcoran Corporation's stock is currently selling at an equilibrium price of $25 per share. The firm has been experiencing a 7 percent annual growth rate. Last year's earnings per share, EPS0, were $4.00 and the dividend payout ratio is 50 percent. The risk-free rate is 5 percent, and the market risk premium is 5 percent. If market risk (beta) increases by 20 percent, and all other factors remain constant, what will be the new stock price? (Use 4 decimal places in your calculations.)

Question

Quizplus · Accepted Answer

The new stock price can be calculated using the Dividend Discount Model (DDM) and adjusting for the new required rate of return due to the increased market risk (beta). The original required rate of return (k) can be calculated using the Capital Asset Pricing Model (CAPM): k = risk-free rate + beta * market risk premium. With a 20% increase in beta, the new beta becomes 1.2 times the original beta. The new required rate of return is then recalculated, and the DDM formula (P0 = D1 / (k - g)) is used to find the new stock price, where D1 is the dividend next year, k is the new required rate of return, and g is the growth rate. The calculation involves finding the original beta from the given information, increasing it by 20%, recalculating the required rate of return, and then applying the DDM formula with the new k.

Corcoran Corporation's Stock Is Currently Selling at an Equilibrium Price