Assignment
Monica Dubois, an ABC investment advisor, has a new client, Mr. Jack Klein. Mr. Klein is a conservative investor who is interested in a required rate of return of 10% on his stock investments while assuming lower market risk. You are asked to help Monica make a suitable portfolio recommendation backed by risk-return calculations. The 3 possible stock choices for Mr. Klein and their respective betas are as follows:
|
Stock
|
Expected Return
|
Beta
|
|
ABC
|
10%
|
0.75
|
|
XYZ
|
11%
|
1.0
|
|
WHY
|
12%
|
1.25
|
Part I
Determine the expected returns and beta for a portfolio consisting of one third of Mr. Klein's funds in each stock.
Part II
Assume the following:
• Each ABC stock pays current dividends of $1.50 annually with 6% expected annual increases. The current market stock price for ABC is $30 per share.
• Each XYZ stock pays current dividends of $1.75 annually with 6% expected annual increases. The current market stock price for XYZ is $27 per share.
• Each WHY stock pays current dividends of $2.25 annually with 7% expected annual increases. Current market stock price for WHY is $35 per share.
Complete the following for this assignment:
• Using the constant dividend growth model, determine whether ABC and WHY are over- or undervalued.
• For what types of companies is the constant growth model an appropriate analysis tool?
• What are the limitations of the constant growth model?