Consider the extended version of the fisher equation

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For this question, consider the “extended” version of the Fisher Equation (R   =   R* + IP + LP + MRP + DRP) as the required rate of return on the stock. Oscar Papa Corp’s dividend is currently $1.75 and is expected to grow by constant 4.00% each year. The required rate of return (i.e., the rate on alternative investments) is 10.4%. As part of this required rate of return, analysts believe that Oscar Papa has a default risk premium of 2.7% (i.e., this is included in the required rate of return of 10.4%). (a) Calculate the estimated value of Oscar Papa’s stock. (b) Now, assume that the economy enters a recession and Oscar Papa is impacted negatively. Analysts now believe that Oscar Papa’s probability of default has doubled, causing the DRP to double. All else equal, recalculate the estimated value of Oscar Papa’s stock with this additional probability of default included.

Reference no: EM131547107

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