Value of risk management, Value of Risk Management. Suppose

Value of risk management

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Reference no: EM132242216

Value of Risk Management. Suppose it is 2030, and Tesla is finally profitable. Suppose that their beta is 2.5, the risk-free rate of return is 2%, and the market rate of return is 7%. Further, assume the current dividend is $3.00 per share, and the dividend is expected to grow at a 4% rate, annually. Now that they are profitable, they want to protect their income stream by developing an ERM program. Use the assumptions above to answer the following questions:

a. What is the required rate of return to holding Tesla stock? Show your work for complete credit.

b. With the required rate of return found in part a, what is the expected price of one share of Tesla stock? Again, show your work and explain your findings for full credit.

c. Now, assume a new CEO would like to demonstrate to the board how an ERM program can increase firm value. Namely, if they diversify out of Lithium-based batteries to new Zinc-based battery technology, their beta will fall from 2.5 to 1.5. Trace through the steps to find the new stock price, and explain carefully how this decision has increased the value of the firm.

Reference no: EM132242216

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