Chapter 12, 4 A share of stock with a beta of 0.81 now sells for $69. Investors

Question

Chapter 12, 4

A share of stock with a beta of 0.81 now sells for $69. Investors expect the stock to pay a year-end dividend of $4. The T-bill rate is 4%, 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.)

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.)

Explanation / Answer

eXPECTED RETURN= DIVIDEND+(FINAL-INITLA)/INITIAL

=4+(71-69)/69=8.70%

using capm the required return is

=Riskfree+(beta*market premium)

=4%+(7%*0.81)=9.6%

The expected return is less than the required return so it is so the stock is bad buy and will not invest

b)9.6%=(4+(x-69))/69

X=71.62

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