Practice Problem – Dividend

Practice Question

Equity Valuation
Dividend
Short Answer

Far North Airlines is expected to pay a dividend of $8 in the coming year. Dividends are expected to decline at the rate of 2% per year. The risk-free rate of return is 6% and the expected return on the market portfolio is 14%. The stock of Far North Airlines Company has a beta of -0.25. What is the price of the stock?

Answer +
Correct Answer: $133.33
Explanation +
Step 1: Calculate the Required Rate of Return using CAPM

Use the Capital Asset Pricing Model (CAPM):
Required Return = Rf + β(Rm − Rf)
= 6% + (−0.25)(14% − 6%)
= 6% − 2% = 4%

Step 2: Use the Dividend Discount Model (DDM)

Use the constant growth DDM:
Price = D₁ / (k − g)
D₁ = $8, k = 4%, g = −2%
= 8 / (0.04 + 0.02) = 8 / 0.06 = $133.33

Conclusion:

Based on the CAPM and DDM, the correct stock price is $133.33.