The market price of a security is $40. Its expected rate of return is 13%. The risk-free rate is 7%, and the market risk premium is 8%. What will the market price of the security be if its beta doubles (and all other variables remain unchanged) ? Assume the stock is expected to pay a constant dividend in perpetuity. (Round your answer to 2 decimal places.)

The market price of the security will be $27.37

Explanation:

Step 1: Determine current risk premium

Current risk premium=Expected rate of return-risk-free rate

where;

Expected rate of return=13%

risk free rate=7%

replacing;

Current risk premium = (13-7) = 6%

Step 2: Determine new risk premium

The risk premium will double if the better doubles

New risk premium = (2*6) = 12%

Step 3: New discount rate for the security

New discount rate for the security=new risk premium+risk free rate

New discount rate for the security = (12%+7%) = 19%

Step 4: Calculate the dividend

We can use the formula;

Price=dividend/discount rate

dividend = (40*13%) = Answer:

Explanation:

Step 1: Determine current risk premium

Current risk premium=Expected rate of return-risk-free rate

where;

Expected rate of return=13%

risk free rate=7%

replacing;

Current risk premium = (13-7) = 6%

Step 2: Determine new risk premium

The risk premium will double if the better doubles

New risk premium = (2*6) = 12%

Step 3: New discount rate for the security

New discount rate for the security=new risk premium+risk free rate

New discount rate for the security = (12%+7%) = $5.20

Step 4: Market price of the security

At a new discount of 19%, the security would be worth;

5.2/0.19=27.37

The market price of the security will be $27.37