Constant growth Video Excel Online Structured Activity: Constant growth You are

Question

Constant growth Video Excel Online Structured Activity: Constant growth You are considering an investment in Justus Corporation's stock, which is expected to pay a dividend of $1.75 a share at the end of the year (D1 -$1.75) and has a beta of 0.9. The risk-free rate is 3.3%, and the market risk premium is SS%Justus currently sells for S29.00 a share, and its dividend is expected to grow at some constant rate, g. The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the question below. Assuming the market is in equilibrium, what does the market believe will be the stock price at the end of 3 years? (That is, what is P,?) Round your answer to two decimal places. Do not round your intermediate calculations. Check My Work Reset Problem Nex Back 417

Explanation / Answer

CAPM equation would get us expected rate of return or required rate of return on equity:

Required rate = Risk-free rate + Beta x Market risk premium

Required rate = 3.3% + 0.9 x 5.5%

Require rate = r = 8.25%

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Now, we required to calculate the growth rate of dividend:

P0 = D1/(r-g)

29 = 1.75/(8.25%-g)

8.25%-g = 1.75/29

g = 8.25% - 6.034483%

g = 2.215517%

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We can now calculate P3 or stock value at point 3 years from P0

P3 = D1 x (1+g)^3/(r-g)

P3 = 1.75*(1+2.215517%)^3/(8.25%-2.215517%)

P3 = $30.97

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