Risk & Capital (Financial Management)

Topics: Capital asset pricing model, Stock, Dividend Pages: 4 (1147 words) Published: May 1, 2011
Risk & Capital, Unit 3 Individual Project
Financial Management - FINA310-1005B-01

In this week’s individual project paper, a set of financial data will be analyzed (via provided XYZ downloaded information, Bloomberg.com, IP provided ‘assumptions’, and Web resources) in order to calculate expected returns and theoretical stock prices for XYZ Corporation. The CAPM (capital asset pricing model) and CGM (constant growth rate) will be used to arrive at the company stock price.

The risk-free rate of interest (krf) value is gathered from the Bloomberg.com website. The 10-year U.S. Treasury bond rate is the risk-free rate. According to the Bloomberg.com, the U.S. 10-year Treasury bond ‘coupon’ is 2.625 or 2.6% (as of Thursday 20, January 2011) (Rates & Bonds: Government Bonds, 2011). The assumed market risk premium is assumed at being 7.5%. Information gathered from the XYZ Stock Information page (downloaded via IP assignment) reveals the following values: * XYZ’s beta (β) = 1.64

* XYZ’s current annual dividend = $0.80
* XYZ’s 3-year dividend growth rate (g) = 8.2%
* Industry Price/Earnings (P/E) = 23.2
* XYZ’s Earnings Per Share (EPS) = $4.87
* U.S. 10-year Treasury bond (risk free rate) = 2.6%
* Market Risk Premium = 7.5%
1. Using CAPM (Brooks, 2010) to calculate the required rate of return (ks), the formula would be: Ks = risk free rate + (market risk premium) x beta
Plugging in the information, ks = 2.6% + (7.5%)1.64 = 2.6% + 12.3 = 14.9% 2. Using the CGM to calculate the current stock price, or theoretical price (Po), a formula will be utilized: Po = D1/ (r – g) where r and g is (rate of return - growth rate) D1 represents the next year dividend. In order to find it, formula is: D0(1+g) …….(D0 represents current dividend, g is growth) D1= $0.80(1 + 8.2%) = $0.80(1 + 0.082) = $0.80(1.082)

Po = $0.80(1.082)/(0.149 - 0.082)
= 0.8656/0.067
= $12.919 or $12.92
3. Per the XYZ...
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