You expect the price of ABC stock to be $69.88 per share a year from now. Its cu

Question

You expect the price of ABC stock to be $69.88 per share a year from now. Its current market price is $55, and you expect it to pay a dividend one year from now of $2.55 per share.

a) What is the stocks expected dividend yield, rate of price appreciation, and holding-period return?

b) If the stock has a beta of 1.20, the risk-free rate is 6.5% per year, and the expected rate of return on the market portfolio is 14.5% per year, what is the required rate of return on ABC stock?

c) What is the intrinsic value of ABC stock, and how does it compare to the current market price?

Explanation / Answer

a) Dividend yield = Dividend paid / current price = 2.55 / 55 = 4.64%

Rate of price appreciation = (69.88 - 55 ) / 55 = 14.88 / 55 = 27.05%

Holding period return = total return / current price = (14.88 + 2.55) / 55 = 31.69%

b) Using CAPM model

Expected return on stock = Risk free return + Beta * (Market Return - Risk free return)

= 6.5% + 1.2 * (14.5%-6.5%) = 16.10%

c) Intrinsic value = present value of (69.88+2.55) = 72.43 / (1+16.10%) = $62.39

This value is greater than the current price of $55

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