Question:

Chicago Corp stock will pay a dividend of $1.32 next year. Its current price is $24.625 per share. The beta
for the stock is 1.35 and the expected return on the market is 13.5%. If the riskless rate is 8.2%, what is
the expected growth rate of Chicago?

Solution:
Using the capital asset pricing model (CAPM),

E( Ri ) = r + βi (E (Rm ) – r)
We first find the expected rate of return as

E( Ri ) = 0.082 + 1.35[0.135 − 0.082]

= 0.082 + 1.35(0.053)

= 0.082 + 0.07155

= 0.082 + 0.07155

= 0.15355 = R

The expected rate of return E(Ri), for a security is also its required rate of return R by the
investors. Using the growth model for a stock, equation

D1
po = R−g

We get

R – g = D1/ Po

Or

g = R – D1/Po
𝟏. 𝟑𝟐
𝐠 = 𝟎. 𝟏𝟓𝟑𝟓𝟓 −
𝟐𝟒. 𝟔𝟐𝟓
𝐠 = 𝟎. 𝟏 Thus the rate of growth is 10%.