Stock X paid a dividend of $2.50 yesterday. It is expected to grow at 7% indefinitely. X's return generally responds to market changes twice as much as does the average stock. Treasury bills currently yield 8%. The market is yielding 11%. What should X sell for today?
A)$38.21
B)$32.14
C)$17.21
D)$35.71

Question

Quizplus · Accepted Answer

First, we need to find X's cost of equity using the Capital Asset Pricing Model (CAPM):

Cost of equity = Risk-free rate + Beta*(Market return - Risk-free rate)
Cost of equity = 8% + 2*(11% - 8%)  (since X's beta is twice the average stock)
Cost of equity = 14%

Next, we can use the dividend discount model to find X's intrinsic value:

Intrinsic value = Dividend / (Cost of equity - Dividend growth rate)
Intrinsic value = 2.50 / (14% - 7%)
Intrinsic value = $35.71

Therefore, X should sell for $35.71 based on its fundamentals. Since this is higher than any of the answer choices, the closest value is A, $38.21, which is the best choice.

Stock X Paid a Dividend of $2