Zanes Candy Company common stock is expected to pay a dividend of $1.45 a share

Question

Zanes Candy Company common stock is expected to pay a dividend of $1.45 a share at the end of this year (D1 = $1.45); its beta is 1.00; the risk-free rate is 4.2%; and the market risk premium is 4%. The dividend is expected to grow at some constant rate g, and the stock currently sells for $60 a share. Assuming the market is in equilibrium, what does the market believe will be the stock's price at the end of 3 years (i.e., what is P3 )? Do not round intermediate steps. Round your answer to the nearest cent.

Explanation / Answer

Required rate of return on the stock using CAPM equation = risk free rate + beta * market risk premium = 4.2% + 1 * 4% = 8.2%

Rate of growth of the stock using DDM model = required rate of return - next year dividend / current stock price

= 8.2% - 1.45 / 60 = 5.78%

Stock price in 3 years = current price * (1+growth rate)^3 = 60*(1+5.78%)^3 = $ 71.02

Hope this helped ! Let me know in case of any queries.

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