Suppose ABC Inc. stock is selling for $200 per share and it is “fairly” priced. It is expected to pay a dividend of $4 at the end of this year. For the next 14 years the dividend will grow at 20% per year. After that the growth rate will moderate to 6% per year. XYZ stock is twice as risky as ABC stock. Each XYZ Corp. share is expected to pay a dividend of $2 at the end of this year and the dividend is expected to grow at the rate of 8% per year for the forseeable future. The expected return on the market portfolio is 15% per year and the risk-free rate is 5% per year.
(a) What is the opportunity cost for ABC stock?
(b) What is ABC stock’s β ?
(c) What is a fair price for XYZ Corp. shares?