Top hedge fund manager Diana Sauros believes that a stock with the same market r
ID: 2766508 • 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 $56. The stock will pay a dividend at year-end of $4.00. Assume that risk-free Treasury securities currently offer an interest rate of 1.9%.
Average rates of return on Treasury bills, government bonds, and common stocks, 1900–2013 (figures in percent per year) are as follows.
What is the discount rate if the interest rate is 4.0%? (Enter your answer as a percent rounded to 2 decimal places.) Discount rate % =?
What price should she be willing to pay for the stock today? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Stock price $ =?
Portfolio Avg Annual Rate of Return Average Premium (extra return versus treasury bills) Treasury bills 3.9 Treasury Bonds 5.2 1.3 Common Stocks 11.5 7.6Explanation / Answer
Answer
Answer 1
What is the discount rate if the interest rate is 4.0%? (Enter your answer as a percent rounded to 2 decimal places.) Discount rate % =?
Discount rate = Interest rate + Average common stock Premium (extra return versus treasury bills)
= 4% + 7.6%
= 11.6%
Answer : If the interest rate is 4.0%, the discount rate is 11.6%
Answer 2
What price should she be willing to pay for the stock today? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Stock price $ =?
Current market price = Upcoming dividend / Cost of equity (i.e. Current Risk free rate + Common stock Avg. premium)
= 4.00 / (1.9% + 7.6%)
= 4.00 / 9.5%
= $ 42.11
Answer : she be willing to pay $ 42.11 for the stock today