You are considering an investment in Justus Corporation\'s stock, which is expec

Question

You are considering an investment in Justus Corporation's stock, which is expected to pay a dividend of $2.25 a share at the end of the year (D1 = $2.25) and has a beta of 0.9. The risk-free rate is 2.9%, and the market risk premium is 6.0%. Justus currently sells for $50.00 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 ?) Round your answer to two decimal places. Do not round your intermediate calculations.

Explanation / Answer

We have to first calculate growth rate g. By useing dividend discount model

P0 = D1/ Ke-g

Here P0 = current market price = $50

Ke = Required return which we can calculate by using CAPM model

Required Return = Rf+ (Rm-Rf) * beta

= 2.9%+(6%) 0.9 = 8.3%

P0 = D1/ Ke-g

$50 = $2.25/ 8.3%- g

g = 3.8%

Growth rate is capital gains yield implying that stock price will increae by this growth rate

Price at the end of the three years P3 = P0* (1+g)^3 = $50*(1.038)^3 = $55.92

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