Question #98
Reading: Reading 20 Discounted Dividend Valuation
PDF File: Reading 20 Discounted Dividend Valuation.pdf
Page: 38
Status: Unattempted
Question
If an asset's beta is 0.8, the expected return on the equity market is 10%, the retention ratio is 0.7, the dividend growth rate is 5%, and the appropriate discount rate for the Gordon model is 9%, the risk-free rate must be closest to:
Answer Choices:
A. 5.0%
B. 2.5%
C. 3.8%
Explanation
Required return = risk-free rate + beta (expected equity market return – risk-free rate)
9% = risk-free rate + 0.8(0.10 – risk-free rate)
9% = 0.08 + 0.2(risk-free rate)
1% / 0.2 = risk-free rate = 0.05 or 5%