Unit 3 Individual Project
Risk and Capital
Yvonnia Carter
American Intercontinental University
August 10, 2013

Introduction This is to introduce how theoretical stock prices are calculated and how these prices react to market forces such as risk and interest rates (AIU, 2013). The first thing to do is find an estimate of the risk-free rate of interest (krf) and the value for the market risk premium. In this case, the (krf) is 2.58 and the market risk premium is 9.00%. Using the information from the XYZ Stock Information, these are the current values: ● XYZ’s Beta (B) is 1.64 ● XYZ’s current annual dividend is $0.80 ● XYZ’s 3-year dividend growth rate (g) is 8.2% ● Industry P/E is 23.2 ● XYZ’s EPS is $4.87 To get the required rate of return you use the following CAPM formula: Beta stock times (market risk premium minus risk free rate of interest) plus risk free rate of interest equals the required rate of return, so therefore (B)1.64* ((KM) 9.00% - (KRF) 2.58) +(KRF) 2.58=13.1088% 0r $13.11 (Ultimatecalculators.com, 2013). To find the current stock price for XYZ, use the following Constant Growth Model (CGM) formula: Current annual dividend times (1 plus growth rate) divided by required return rate minus growth rate, so therefore (D) $0.80 * (1 + (G) 8.2%) / (KS) 13.1088% - (G) 8.2% = (PO) $17.63 (Ultimatecalculators.com, 2013).
Are there any differences? Yes, there are some differences. As you can see from the stock information sheet, XYZ’s current price is listed at $76.28 and the theoretical price came out to be $17.63.
What factors may be at work for such a difference in the two prices? There are a few factors that affect the outcome of the price difference. The first factor is the risk-return tradeoff that is set by the company. The second is the company earnings per share. The third is the increase in the dividend