You are considering an investment in Crisp\'s Cookware\'s common stock. The stoc

Question

You are considering an investment in Crisp's Cookware's common stock. The stock is expected to pay a dividend of $2 a share at the end of the year (D1 = $2.00); its beta is 1.10; the risk-free rate is 5.9 %; and the market risk premium is 5%. The dividend is expected to grow at some constant rate g, the stock currently sells for $29 a share. Assuming the market is in equilibrium, what does the market believe will be the stock price at the end of 3 years (i.e., what is P??3 )? Round your answer to the nearest cent.

Explanation / Answer

We first calculate the growth rate g Using the dividend disoc**t model P0 = D1/(Ke-g) Here P0 = current market price = $25 Ke = reruired return, which we can calculate using the CAPM equation Required return = Rf + (Rm-Rf) X beta = 5.6% + 6%X0.9 = 11% D1 = expected dividend = $2.00 We get 25 = 2/(11%-g) Solving gives g as 3% Growth rate g is the capital gains yield implying that the stock price will increase by this growth rate Price at the end of three years P3 = P0 X (1+g)^3 = 25 X (1+3%)^3 = $27.32

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