Top hedge fund manager Diana Sauros believes that a stock with the same market r
ID: 2745852 • Letter: T
Question
Top hedge fund manager Diana Sauros believes that a stock with the same market risk as the S&P 500 will
sell at year-end at a price of $48. The stock will pay a dividend at year-end of $4.00. Assume that risk-free Treasury
securities currently offer an interest rate of 2.2%. Average rates of return on Treasury bills, government bonds, and common stocks,
1900 -2013 (figures in percent per year) are as follows.
Average Annual Rate of Return Average Premium (Extra return versus Treasury bills)
Portfolio
Treasury Bills 3.9
Treasury bonds 5.2 1.3
Common Stocks 11.5 7.6
a. what is the discount rate on the stock? (Enter your answer as a percent rounded to 2 decimal places)
Discount rate ____________%
b. what price should she be willing to pay for the stock today?(do not round intermediate calcualtions. Round your answer to 2 decimal places)
stock price $_______________
Explanation / Answer
1) Calculation of Discount rate / Required rate of return :
Discount rate = Risk free rate + Market risk premium
= 2.2 % + 7.6 %
= 9.8%
2) Calculation of price what she be willing to pay for the stock today :
Stock price = dividend / Required rate of return
= 4 / 9.8%
= $40.816
She would be willing to pay $40.816 to day for the stock.