Question

A share of stock with a beta of 0.84 now sells for $69. Investors expect the stock to pay a year-end dividend of $4. The T-bill rate is 3%, and the market risk premium is 7%.a. Suppose investors believe the stock will sell for $71 at year-end. Calculate the opportunity cost of capital. Is the stock a good or bad buy? What will investors do? (Do not round intermediate calculations. Round your opportunity cost of capital calculation as a whole percentage rounded to 2 decimal places.)Opportunity Cost of Capital ________%?b. At what price will the stock reach an "equilibrium" at which it is perceived as fairly priced today? (Do not round intermediate calculations. Round your answer to 2 decimal places.)Stock price-__________________?

Answer 1

Consider the following calculations

Step-by-step explanation:

r=rf + B X (rm-rf)

rf=3%

B=0.84

rm-rf=7%

r=8.88%

So, given the market risk premium and beta, the return should be 8.9% by above equation

If he buys the stock

Total return=Dividend+ capital appreciation

4+(71-69)=6

Return%=8.70% (6/69)

Opprtunity cost is 8.9% as given the beta of stock and market risk premium, 8.9% should be the return.

But, the above stock is expected to give only 8.7% return (dividend and capital gain), so he should not invest, bad buy.