this is just some stupid question i found in an old textbook but im having trouble answering it. a company’s stock is currently paying 2.5 per share, dividends are expected to growth at a constant rate of 6% per annum. the stock’s beta is 1.5 the required rate of return on the market is 15% and the risk free rate is 7%, the firm is considering a strategy that will increase its beta to 1.75. if all else remains unchanged what would the new constant growth rate have to be in order for the firms stock price to remain unchanged. using capm i found that the required return @ 1.5 beta is 19% at 1.75 beta its 21% and i found the current stock price to be 20.38 using the constant growth model. my problem is determining the new growth rate using the constant growth model, maybe im using the wrong method but im also having trouble with the algebra to solve 2.5(x) / .21 - x = 20.38(1.21) Any help would eb appreciated.
presumably that’s 2.5x/(0.21 - x) = whatever just multiply each side by (.21 - x) collect your terms…
JoeyDVivre Wrote: ------------------------------------------------------- > presumably that’s 2.5x/(0.21 - x) = whatever > > just multiply each side by (.21 - x) collect your > terms… thats what i got I guess i screwed up and used the wrong method to determine the new growth rate cuz when i plug in the new X its close to what it should be but not quite.
technically that should be 2.5(1+x) on the top.
Management & board of directors are at a meeting… CEO: “Hey guys! I’m bored. I’d like to increase our beta!” BOD Member: “Huh?” CEO: “I’m going to do some random stuff to our firm to make it’s performance more sensitive to the performance of a bunch of other stocks called an index. If the index goes up, we’ll go up even more! We’ll look like friggin’ geniuses and our options will rock. If the index goes down, don’t worry, we’ll still get our salaries. Are you feelin’ lucky!?!” BOD member: “That’s why you make the big bucks! Increase that beta baby!”
He he, that’s funny! More seriously, aside from obtaining more (or reducing) leverage, how would a company deliberately manipulate its beta? I suppose a merger with a different company in a different line of business or with a dramatically different cost structure might do it? Anything else?
2.5 (1+g)/(.21-g) = 20.38 2.5 + 2.5g = 4.2798 - 20.38g -1.7798 = -22.88g .07788 = g all else remains the same so i take it the stock price remains at 20.38