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Question - ABC Company Pte Ltd has just paid out a dividend of $10. The annual dividend is expected to grow at a constant rate of 5% in the first 3 years. Thereafter, it is expected to be held constant. You can assume the risk-free rate is 3%, beta is 1.5 and the expected market return is 7.5%.
(a) Explain how you can obtain the values of risk-free rate, beta and expected market return from the financial markets.
(b) Find the value of the stock assuming that it is currently the start of the year.
(c) You need to fund the purchase of the stock with a bank loan with a rate of 12%. Is the purchase of the stock a good investment?
(d) Bank lending rates tend to fluctuate and analysts believe that the lending rate will follow the distinguished Normal distribution with mean of 12% and volatility of 3%. What is the probability that the purchase of the stock is a good investment?
Hubbard argues that the Fed can control the Fed funds rate, but the interest rate that is important for the economy is a longer-term real rate of interest. How much control does the Fed have over this longer real rate?
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