Problem:
The risk free rate of return is 3% and the market rate of return is 12%. Penn Trucking has a beta of 2 and a standard deviation of returns of 28%. Penn Trucking's marginal tax rate is 35%. Analysts expect Penn Trucking's dividends to grow by 6% per year for the foreseeable future.
Required:
Question 1: What is the risk premium?
Question 2: Using the capital asset pricing model, what is Penn Trucking's required rate of return on its common stock?
Question 3: If Penn has a current return of 21% and has just paid a dividend of $1.50, what is the value of its stock?
Note: Provide support for your underlying principle.