Carlson Products, a constant growth company, has a current stock price of $20.00
ID: 2687844 • Letter: C
Question
Carlson Products, a constant growth company, has a current stock price of $20.00. Carlson's next dividend, D1, is forecasted to be $2.00, and is expected to grow at an annual rate of 6%. Carlson has a beta coefficient of 1.2, and the market risk premium is 5%. As Carlson's financial manager, you have access to insider information concerning a switch in product lines that would not change the growth rate, but would cut Carlson's beta coefficient in half. If you buy the stock at the current market price, what is your expected percentage capital gain? Answer 23% 33% 43% 53% There would be a capital loss.Explanation / Answer
The required rate of return on the stock = 9% + (6%)0.8 = 13.8%.
constant growth model
we can solve for the growth rate as follows:
$2(1 + g) $40 = 0.138 g $5.52 - $40g = $2 + $2g $42g = $3.52 g = 8.38%.
Capital gains
rs, the required rate of return: $2 rs = + 6% = 10% + 6% = 16%. $20
rRF, the risk-free rate: 16% = rRF + 5%(1.2) 16% = rRF 10% rRF = 10%
new stock price and capital gain: New rs = 10% + 15%(0.6) = 13%. $2 = $28.57.
New = 0.13 - 0.06
Therefore, the percentage capital gain = 43% answer