Reference no: EM132993444

You are considering buying shares in Chattanooga Railways. The stock is currently trading for $17.24. Analysts expect the next annual dividend to be $1.25. (The next dividend will be paid in one year.) Dividends are expected to grow in perpetuity at the annual rate of 2%. Chattanooga's beta is 1.077. The risk-free rate is 2% and the expected return on the market is 8.5%. Use this information to answer the questions that follow.

Problem 1: What annual return will you earn on Chattanooga if you buy it today, hold it, and receive the perpetual stream of growing dividends?

a) 9.05%
b) 8.75%
c) 9.25%
d) 8.55%

Problem 2: Under the CAPM, what is the equilibrium rate of return on Chattanooga's shares given its systematic risk?

a) 9.6%
b) 9.4%
c) 9.0%
d) 8.6%

Problem 3: Draw the Security Market Line and plot Chattanooga's risk and return point.

3.1: Chattanooga plots ___________ the SML
a) below
b) above
c) on

3.2: Chattanooga's stock price is currently
a) fair
b) expensive
c ) cheap