1. DesinceLogic is a fast growing company that distributes 20% of its earnings as dividends. An institutional investor plans to hold the company stock for 10 years. The investor seeks 15% rate of return and expects the stock to be traded at 30 times earnings at the end of 10 years. Current earning is $4/share (E0=4). Earning with grow at a rate of 21% during the first year and decline by 3% every year during the following 4 years reaching 9% in year 5. The growth rate will continue to be 9% for the remaining 5 years.
Use the combined earnings and dividend model to determine the current value of the stock. TimeGEarningsDividendFuture PriceD+FPPV0 $ 4.00 10.2123450.0960.0978910Stock Value
How much is the growth rate after year 10? Answer
2. (25 Points) The following table gives hypothetical data on 2 stocks in a hypothetical portfolio in addition to the risk free rate of return along with market portfolio return.
Track the portfolio expected return standard deviation and Beta for a mix of the 2 stocks that changes in 10% increments starting with the portfolio fully invested in Y(Wy ?100% Wx ? 0%) and ending up with the portfolio fully invested in X (Wx ?100% Wy ? 0%) as shown on the attached table.
Is the expected return given consistent or inconsistent with CAPM? Explain your answer.
Answer
Inputs
S.D.
E(R)
Beta
Risky Asset X
20.0%
16.0%
2.5
Risky Asset Y
15.0%
12.0%
1.5
Correlation (r)
0.0%
Risk Free Rate (Rf)
0.0%
6.0%
0
Market Portfolio
10.0%
1
Outputs
Wx
E(Rp)
SDp
Bp
EPF
0.0%
10.0%
20.0%
100.0%Page 3 of 3
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