Problem (20 points) The McKeever Corporation recently paid a $2.50 div

QUESTION

Problem (20 points)
The McKeever Corporation recently paid a $2.50 dividend; this dividend is expected to grow
at a constant rate of 3 percent per year for the indefinite future. The 1-year T-Bill is currently
yielding 4.5 percent, and the required return on the overall market is 8.5 percent. McKeevers stock has a beta of 1.2.
a) What is the required return on McKeevers stock?
b) Based on this, at what price do you expect McKeevers stock to be selling today?
c) If McKeevers stock is actually selling at $39.50, what is its expected rate of return?
d) What must happen in order for McKeevers stock to be in equilibrium? Explain briefly
what investors will do and when this behavior will stop.
1. Dividend = $2.5 Growth rate=3% annually till infinity Risk free rate=4.5% Market return=8.5% Beta of stock=1.2 a) Required return = Risk free rate + beta * (Market return-Risk free rate) =4.5%+1.2*(8.5%-4.5%)=9.3% b) (2.5*1.03)/(9.3%-3%) =¦

$40.87 c) Rate of return = (40.87-39.50)/39.50 = 3.47% d) if in equilibrium the investors would keep on buying and selling the stock until it reached equilibrium.

ANSWER:

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