Salt Lake City Services Inc. provides maintenance services for commercial buildings. Currently

QUESTION

Salt Lake City Services, Inc., provides maintenance services for commercial buildings. Currently, the beta on its common stock is 1.08. The risk-free rate is now 10 percent, and the expected return on the market portfolio is 15 percent. It is January 1, and the company is expected to pay a $2 per share dividend at the end of the year, and the dividend is expected to grow at a compound annual rate of 11 percent for many years to come. Based on the CAPM and other assumptions you might make, what dollar value would you place on one share of this common stock?
Solution: As per CAPM, cost of equity is = Risk-free rate + Beta * (Market Return Risk-free rate) = 10% + 1.08 * (15% 10%) = 15.4% Value of Share at the end of Year 1 = Dividend at the end of Year 1 * (1 + Perpetual growth rate) / (Cost of equity

Perpetual growth rate) = $2 * 1.11 / (15.4% 11%) = $50.45 Value of share as on today = Value at the end of year 1 / (1 + cost of equity) = $50.45 / 1.11 = $45.45

ANSWER:

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