A stock is about to pay a dividend of $2.00. The dividend is expected to grow at 15% for the next 7 years, 10% for the following 3 years, 8% for the next 2 years and then return to the long run growth rate of 5%.
(a) Suppose the stock has a CAPM beta coefficient of 1.2, the current riskless rate of interest is 1 % and the current market risk premium is 8%. What is the appropriate risk adjusted discount rate for the stock according to CAPM?
(b) What should the current value of the stock be?
(c) If the long run growth rate increased to 6%, how much would the stock price change in percentage terms?
(d) If each of the initial high growth periods had growth rates 1 percentage point higher (so the rates were 16%, 11 % and then 9%) but the long run growth rate remained at 5 %, how much would the stock price change in percentage terms?
(e) If the market risk premium changed to 10% (while the riskless rate remained at 1 %), what would happen to the appropriate risk adjusted discount rate for the stock according to CAPM?
(f) If the market risk premium changed to 10% (while the riskless rate remained at 1 %), what would happen to the percentage changes in the stock price calculated in (c) and (d).
(g) Can you explain intuitively the different relative effects on the stock price of the changes in long run versus short run growth when the market risk premium is higher?