Question

A share of stock sells for $35 today. The beta of the stock is 1.2 and the expected return on the market is 12 percent. The stock is expected to pay a dividend of $0.80 in one year. If the risk-free rate is 5.5 percent, what should the share price be in one year?

Answer 1

$38.78

Step-by-step explanation:

The formula to compute the share price in one year is shown below:

Price of a stock = (Next year dividend) ÷ (Required rate of stock return - growth rate)

where,

Price of the stock = Next year dividend ÷ (Risk free rate + beta × (Market return - Risk free rate) - Dividend growth rate)

$35 = $0.80 ÷ (5.5% + 1.2 × (12% - 5.5%) - g)

So after solving this

The growth rate is 11.01%

Now the share price after one year is

= 0.80 × (1 + 11.01%) ÷ (13.3% - 11.01%)

= $88.81 ÷ 2.29%

= $38.78