You are considering an investment in Keller Corp\'s stock, which is expected to
ID: 2722115 • Letter: Y
Question
You are considering an investment in Keller Corp's stock, which is expected to pay a dividend of $2.00 a share at the end of the year (D1 = $2.00) has a beta of 0.9. The risk-free rate is 5.6%, and the market risk premium is 6.0%. Keller currently sells for $25.00 a share, and its dividend is expected to grow at some constant rate g. 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 P3?) Round your answer to two decimal places.
Explanation / Answer
As per CAPM Expected Return (r) = risk free rate + beta * market risk premium
r = 5.6% + .9 * 6%
r = 11%
Current market price = Dividend / r-g
25 = 2 / .11 - g
g = 3%
D1 = $2
D2 = 2 * (1.03) = $2.06
D3 = 2.38 * (1.19) = $2.12
Stock Price = Dividend / r - g
= 2.12 /.11-.03
= $26.50
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