in a) she is saying the $5 dividend needs to represent an 11% return, so 11/100 = $5/x Solve for x and you get $45.45 per share.
in b) she is saying the $5 annual dividend needs to represent a 12% return, so 12/100 = $5/y Solve for y and you get $41.67
c) The second calculation discounts the share value to compensate for additional perceived risk. It may influence her decision to continue holding, or to sell her shares. If the market price is near $45, then the market doesn't value the risk as highly as she does and that may persuade her to sell and avoid the risk.
Suppose that Melanie is valuing the stock she holds in Kartonic Corporation. She expects to receive a dividend of $5 by the end of next year, and the same amount every year thereafter. However, she suspects that management has misrepresented the company’s financial health in the firm’s financial statements, and that things at Kartonic are not quite as rosy as they seem.
a) Using the CAPM, Melanie estimates the required return for Kartonic’s stock to equal 11%. Based on this estimate, what would be Melanie’s estimate for a fair value of Kartonic’s stock?
b) If Melanie wishes to include a 1% credibility risk premium to compensate her for the lack of integrity she suspects inside Kartonic, and the fact that she does not trust the firm’s financial statements, what would be her estimate of the fair stock price then?
c) Explain the difference between the stock prices you have calculated for parts a and b. Would this influence Melanie’s willingness to continue holding Kartonic’s stock?
