IntegrativeRisk and valuation Giant Enterprises stock has a required return of 14.8%. The company

QUESTION

IntegrativeRisk and valuation Giant Enterprises stock has a required return of 14.8%. The company, which plans to pay a dividend of $2.60 per share in the coming year, anticipates that its future dividends will increase at an annual rateconsistent with that experienced over the 20062012 period, when the following dividends were paid:YearDividend per share2012$2.4520112.2820102.1020091.9520081.8220071.8020061.73a. If the risk-free rate is 10%, what is the risk premium on Giants stock?b. Using the constant-growth model, estimate the value of Giants stock.c. Explain what effect, if any, a decrease in the risk premium would have on the value of Giants stock.
a. Periods 1 2 3 4 5 6 7 Rate of return 14.80% Years 2006 2007 2008 2009 2010 2011 2012 Risk free rate 10% Dividend per share 1.73 1.8 1.82 1.95 2.1 2.28 2.45 Rate of return=risk free rate+risk premium Rate of return-Risk free rate Risk premium 4.80% According to CAPM formula Rate of return=Risk free rate + Risk Premium Rate of return=14.8%, Risk free rate=10% Risk premium = 14.8% 10% = 4.8% b. Periods 0 1 2 3 4 5 6 7 8 Rate of

return 14.80% Years 2006 2007 2008 2009 2010 2011 2012 2013 Dividend per share (DPS) 1.73 1.8 1.82 1.95 2.1 2.28 2.45 2.6 Present value of DPS @ 14.8% 1.51 1.37 1.20 1.12 1.05 1.00 0.93 0.86 Value of stock (Sum of PV of DPS) $9.04 c. As risk premium decreases the value of stock increases.

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