The risk-free rate of return, r RF , is 5%; the required rate of return on the

Question:

The risk-free rate of return, r_RF, is 5%; the required rate of return on the market, r_M, is 8%; and Schuler Company's stock has a beta coefficient of 1.5.

a. If the dividend expected during the coming year, is $2.25, and if g = a constant 5%, at what price should Schuler's stock sell?

b. Now, suppose the Bank of Canada increases the money supply, causing the risk-free rate to drop to 4% and r_M to fall to 7%. What would this do to the price of the stock?

c. In addition to the change in part b, suppose investors' risk aversion declines; this fact, combined with the decline in r_RF, causes r_M to fall to 6.5%. At what price would Schuler's stock sell?

d. Now, suppose Schuler has a change in management. The new group institutes policies that increase the expected constant growth rate to 5.5%. Also, the new management stabilizes sales and profits, and thus causes the beta coefficient to decline from 1.5 to 1.3.

Assume that r_RF and r_M are equal to the values in part c. After all these changes, what is Schuler's new equilibrium price? (Note: D1 goes to $2.26.)

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