Question

A share of stock is now selling for $125. It will pay a dividend of $8 per share at the end of the year. Its beta is 1. What must investors expect the stock to sell for at the end of the year? Assume the risk-free rate is 7% and the expected rate of return on the market is 19%. (Round your answer to 2 decimal places.)

Answer 1

Investors must pay $140.75 for the share

Step-by-step explanation:

Using Miller and Modgiliani CAPM formula, the return on the stock is calculated thus:

ERi​=Rf​+βi​(ERm​−Rf​)

Rf is the risk-free rate of 7%

Beta is 1

(ERm​−Rf​) =19%-7%=12%

ERi=7%+1(12%)

ERi=19%

the expected selling price can be computed using the below formula:

return on investment=(expected selling price+dividend)/current price+1

return on investment is 19%

dividend $8

current price $125

expected selling price is the unknown

0.19=(expected selling price +$8)/$125+1

1.19=(expected selling price +$8)/$125

1.19*$125=expected selling price +$8

expected selling price =(1.19*$125)-$8

=$140.75