You are currently considering buying the stock NPU, Inc, which has a beta of 1.2

Question

You are currently considering buying the stock NPU, Inc, which has a beta of 1.22. The returns in the market are presently 13.5% and the risk free rate of return 3.3%. You expect the price to rise to $31.93 in exactly 2 years. You will receive a dividend of $1.25 at the end of the first year and $1.33 at the end of the second year. Assume the growth in dividend is unpredictable and unsustainable over the years.

A. what is the return you should demand from this stock?

B. What should the stock be selling for according to your calculation?

Explanation / Answer

1. Expected return as per CAPM = Risk free rate + (Market interest rate - Risk free rate) * Beta

= 3.3 + (13.5 - 3.3)*1.22

= 15.74%

2.

Price of stock = Dividend at the end of first year / Cost of Equity

= 1.25 / 0.1574

= $7.94

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