The market price of a security is $40. Its expected rate of return is 13%. The risk-free rate is 7%, and the market risk premium is 8%. What will the market price of the security be if its beta doubles (and all other variables remain unchanged)? Assume the stock is expected to pay a constant dividend in perpetuity. (Round your answer to 2 decimal places.)

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14-11-2019
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The market price of a security is $40. Its expected rate of return is 13%. The risk-free rate is 7%, and the market risk premium is 8%. What will the market price of the security be if its beta doubles (and all other variables remain unchanged)? Assume the stock is expected to pay a constant dividend in perpetuity. (Round your answer to 2 decimal places.)

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Nonicorp1 Nonicorp1 · Answer 1 · 2019-11-14T16:03:28+01:00

Answer:

The market price of the security will be $27.37

Explanation:

Step 1: Determine current risk premium

Current risk premium=Expected rate of return-risk-free rate

where;

Expected rate of return=13%

risk free rate=7%

replacing;

Current risk premium=(13-7)=6%

Step 2: Determine new risk premium

The risk premium will double if the better doubles

New risk premium=(2×6)=12%

Step 3: New discount rate for the security

New discount rate for the security=new risk premium+risk free rate

New discount rate for the security=(12%+7%)=19%

Step 4: Calculate the dividend

We can use the formula;

Price=dividend/discount rate

dividend=(40×13%)=Answer: