A stock has a beta of 0.85 and the risk-free rate is 6.95%. Its dividend growth rate is 5.2% and its P/E ratio is 11.6. If the firm has a dividend payout ratio of 63%, the market risk premium equals ________.
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A. B. C. D.D
P0/E1 = dividend payout/(k - g) Therefore, 11.6 = 0.63/(k - 0.052), giving expected return = k = 10.63%. Now, the CAPM expected return on the stock is given by k
= Rf + beta*(Rm - Rf). Therefore, 10.63% = 6.95% + 0.85*market premium, giving market premium = (10.63 - 6.95)%/0.85 = 4.33%.