Calculate the required rate of return using the Capital Asset Pricing Model (CAPM).
Gloria the Investor
Gloria is a seasoned sales manager with a very large international company. Although she has a great deal of experience with sales, she has little experience with investing. Gloria has been investing in her companys 401K plan. However, she has decided to invest some extra money on her own. Gloria has $75,000 she would like to invest.
Since she has recently signed up for internet access to a broker, she is allowed a small number of phone calls to a broker at no additional charge to her.
She calls ABC investments and talks with a Mr. Bill. She tells Mr. Bill she would like to invest in undervalued stocks and can he recommend about ten stocks for her to research. Mr. Bill tells Gloria his company has about 15 stocks they believe are undervalued and will outperform the marker over time. Mr. Bill gave her the company web site where she can down load that list of stocks.
Below is a list of those stocks:
| rating | Current Stock Price | Current Dividends | 5-Year Avg. Dividend Growth | Current Beta | |||
| 1 | $12.05 | $0.95 | 0.65 | 0.65 | |||
| 2 | $28.02 | $0.00 | -100.00 | 2.3 | |||
| 3 | $17.75 | $0.00 | 0.00 | 1.89 | |||
| 4 | $92.43 | $1.30 | 6.23 | 1.2 | |||
| 5 | $63.79 | $0.75 | 0.95 | 1.35 | |||
| 6 | $2.88 | $0.00 | -8.00 | 1.05 | |||
| 7 | $10.00 | $0.00 | 0.00 | 1.78 | |||
| 8 | $49.51 | $0.68 | 0.75 | 0.95 | |||
| 9 | $101.00 | $5.00 | 0.38 | 0.92 | |||
| 10 | $39.78 | $0.00 | -90.00 | 1.5 | |||
| 11 | $29.75 | $2.00 | 2.25 | 0.85 | |||
| 12 | $73.09 | $0.00 | -1.00 | 0.38 | |||
| 13 | $20.39 | $6.00 | 5.25 | 0.71 | |||
| 14 | $18.25 | $0.00 | 0.00 | 1.2 | |||
| 15 | $7.00 | $1.35 | 8.85 | 0.73 | |||
| Current Treasury Bond Rate | 4.30% | ||||||
| Average return on the Broad Market | 11.90% | ||||||
- Calculate the required rate of return using the Capital Asset Pricing Model (CAPM).
- Using the constant growth formula, calculate the value of each stock
- Compare the values you calculated in questions 1 & 2. Do the values closely approximate the stocks market price? If not, why not?
- What do your results mean for Gloria?
- Are there other options Gloria might consider for valuing stocks?
- How does your result affect the market efficiency theory?
