CFA Practice Question

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CFA Practice Question

A company's required rate of return is 13.1%. An analyst expects the company to pay $10 in dividends next year. The company's stock is currently trading at $60 and is expected to fall to $58 by the year-end. The alpha of the company is
A. 0.2%
B. 0.0%
C. -0.2%
Explanation: Expected holding period return is the sum of dividend yield and price appreciation: r = D1/P0 + (P1 - P0)/P0 = 10/60 + (58 -60)/60 = 13.33%.
Alpha equals the difference between this expected holding-period return and the required rate of return: alpha = 13.33 - 13.1% = 0.2%.

The positive value of alpha indicates that the stock is an attractive stock for investors with a single-period horizon.

User Contributed Comments 2

User Comment
siggarusfigs why don't we discount the cash flows to the present?
DariSH You can easily apply DCF method here too:
1. Do the DDM calc: (58+10)/(1+0.131) = 60.123
2. calc the alpha, %: (60.123-60)/60 = 0.00205
or 0.2%.
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