Problem 1
The current market price of the Microsoft stock is $97 and the company has just paid a 42 cents per share quarterly dividend. The Microsoft's growth rate of dividends is 10% per year.
a. According to the constant dividend growth model, what is the annualized expected return on Microsoft?
You obtained additional information about Microsoft stock. You learned that the annual standard deviation of returns on Microsoft stock is approximately 33%. The correlation
coefficient between returns on Microsoft stock and returns on the S&P 500 index is 0.8. You also estimated that the expected return on the S&P 500 index (the proxy for the market portfolio) is 10% per annum and its standard deviation is 16% per annum. The average return on 3-months Treasury bills (the proxy for the risk free rate) is 3% per annum. Use this additional information to answer the following questions:
- According to CAPM, what is the beta of Microsoft?
- According to CAPM, what is the expected annual return on the Microsoft stock?