d. 26.87 percent e. 50.07 percent 8 Stock Y\'s return has 20 percent more moveme
ID: 1175780 • Letter: D
Question
d. 26.87 percent e. 50.07 percent 8 Stock Y's return has 20 percent more movement than the return on the market. The nominal risk-free rate is 1.5 percent, and the expected rate of return on an average stock is 8 percent. The current price for Stock X is $44.57, the next expected dividend is $1.10, and the stock's expected constant growth rate is 7 percent. Should you buy this stock? Calculate the equilibrium value of i a. No, the equilibrium price of the stock is $44.21 so the stock is overvalued for its risk level. b. Yes, the equilibrium price of the stock is $44.21 so the stock is undervalued for its risk level. c. No, the equilibrium price of the stock is $47.83 so the stock is overvalued for its risk level. d. Yes, the equilibrium price of the stock is $47.83 so the stock is undervalued for its risk level. e. Yes, the equilibrium price of the stock is $44.57 so the stock is valued correctly for its risk level. 2 e stock and decide if it's worth the price above.,) 1 10 0 L neted cash flows of $500
Explanation / Answer
Equilibrium stock price=Future dividend/(Required rate of return-Growth)
Required rate of return=Risk free return+beta*(market rate-risk free rate)
Note:We will take beta to be 1.2 because 20% more volatile from market beta 1.Hence, beta=1+0.2
=1.5+1.2(8-1.5)
=1.5+7.8
=9.3%
Equilibrium stock price=1.1/(0.093-0.07)
=47.8261
Equilibrium price of 47.83 is greater than actual price of 44.57 which shows that the stock is undervalued , so buy the stock. Hence, option d is correct.
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