Praxair's upcoming dividend is expected to be $2.25 and its stock is selling at $65. The firm has a beta of 0.8 and is expected to grow at 10% for the foreseeable future. Compute Praxair's required return using both CAPM and the constant growth model. Assume that the market portfolio will earn 10 percent and the risk-free rate is 3 percent.
A) CAPM: 8.6%; Constant Growth Model: 13.46%
B) CAPM: 9.7%; Constant Growth Model: 12.56%
C) CAPM: 10.1%; Constant Growth Model: 11.46%
D) CAPM: 8.2%; Constant Growth Model: 9.56%

Question

Quizplus · Accepted Answer

Using CAPM:
Required return = Rf + β(Rm - Rf)
Rf = 3%
β = 0.8
Rm = 10%

Required return = 3% + 0.8(10% - 3%) = 8.6%
Using constant growth model:
Required return = (Dividend/Price) + growth rate
Dividend = $2.25
Price = $65
Growth rate = 10%

Required return = (2.25/65) + 10% = 13.46%

Therefore, the best choice is A, as it correctly calculates the required return using both the CAPM and constant growth model.

Praxair's Upcoming Dividend Is Expected to Be $2