Question

A share of stock with a beta of 0.76 now sells for $51. Investors expect the stock to pay a year-end dividend of $3. The T-bill rate is 3%, and the market risk premium is 6%. If the stock is perceived to be fairly priced today, what must be investors’ expectation of the price of the stock at the end of the year?

Answer 1

$51.86

Step-by-step explanation:

In this question, we apply the Capital Asset Pricing Model (CAPM) formula which is shown below

Cost of equity = Risk-free rate of return + Beta × (Market rate of return - Risk-free rate of return)

= 3% + 0.76 × 6%

= 3%+ 4.56%

= 7.56%

The Market rate of return - Risk-free rate of return) is also known as the market risk premium and the same is applied.

Now the stock price at the end of the year would be

Price of stock = (Today price + dividend ) ÷ (1 + cost of equity)

$51 = (Today price + $3) ÷ (1 + 7.56%)

So, the today price would be

= $51.86