A firm's stock has a coefficient of variation of 0.85. It has a beta of 1.23 and a firm specific variance of 0.06. The market portfolio has an expected return of 14% and a standard deviation of 19%. The firm has a payout ratio of 0.3 and it obtains a return on equity equal to 10.3%. The firm's stock is trading at $25.1 per share.
The risk-free rate in the economy is 5.4%. What's the dividend that the market expects the firm to pay out next year?
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A. B. C. D.A
The Dividend Discount Model implies that the firm's share price is given by Po = D1/(k-g), using standard notation. The dividend growth rate is given by g = ROE*
(1-dividend payout ratio) = 10.3% * 0.7 = 7.21%. The CAPM expected rate of return on the stock is equal to the risk-free rate plus beta times the market premium.
So the expected return on the stock is 5.4% + 1.23*(14 - 5.4)% = 15.98%. Therefore, the firm is expected to pay out $25.1*(15.98% - 7.21%) = $2.2.