Simple question here that’s frustrating me. Following info applies to World Turn Co.: *10% rate of interest on newly issued bonds *7% growth rate in earnings and dividends. *The last dividend paid was $0.93 *Shares Sell for $16 *Risk-Free Rate of interest is 5% *Market Risk Premium is 6% *Stock’s Beta = 1.5 *The firm is in a 40% marginal tax bracket If the appropriate risk premium relative to the bond yeild is 4%, World turns equity cost for cap using ddm and the capm is closest to. When I compute the capm I always use. RFR + Beta(Expected Return - RFR) But the solution uses RFR + Beta * Market Risk Premium Does the market risk premium already exclude the RFR? What am I missing? Thanks in advance.
haha i just did that one… market risk prem. = market return - RFR
Thank you, these gotchas are going to be the death of me!!! Wait…then what about the DDM? I’ve always thought that was just D/Expected Return - Growth. UG…
The market risk premium in the CAPM isn’t really a gotcha - It’s actually pretty integral to the equation…
yea…so here you have Div1/Stock price + g DDM and CAPM are two different models and can give different required return…it’s just sometime you have to use CAPM to get k to get the stock price and in this problem it’s the other way around
Obviously the market risk premium is an important part of the equation. For me It’s just a matter of remembering that the market risk premium is not the same as the market return. Right…the ddm can be reworked to give k. Sorry for the dumb question. Thanks for your help guys.