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Suppose that the rate of return on the market portfolio is 12% and the risk-free rate is 4%. Consider a stock with β = 1.5. The firm is expected to have no earnings for three years (E1 = E2 = E3 = 0), and then $10 earnings-per-share for two years (E4 = E5 = 10). After that, earnings are expected to grow at a constant annual rate of 10%. Suppose that the retention ratio is 80% in all periods. Find the fundamental value of the stock. What would happen to the fundamental value if the asset beta falls to β = 1.2?

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Financial Management, Finance

Category:- Financial Management
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