per CAPM: E(r) = RFR + ?(Rmkt - RFR), where (Rmkt - RFR) is referred to as the Market Risk Premium
If by "Equity Premium" you mean Market Risk Premium
E(r) = 2.5% + 0.8(6.4%)
E(r) = 2.5% + 5.12% = 7.62%
Price = Div1 / E(r)
P = 0.50 / 0.0762 = $6.56
It looks like they try to trick you here by mentioning the growth rate. CAPM considers the firm's risk, as reflected by beta, in determining the required rate of return. Using the CAPM rate to determine the price, results in a price that plots ON the Security Market Line "SML". It would be inaccurate to use the Gordon growth model WITH the CAPM rate [Gordon: P0 = D1 / (r - g) ] because that would result in a return that plots BELOW the SML, and your estimate of the stock's value would be OVERpriced.
Again, this assumes "Equity Premium" = Market Risk Premium (sometimes referred to as the Market Equity Risk Premium)
The stock you are considering has a Beta of 0.80; Your analysis indicates that the company should pay a Dividend in one year of $0.50 per share and that the Dividend should grow at 2.2% per year. According to your research and the CAPM, what is the stock’s intrinsic value?
