Constant growth You are considering an investment in Keller Corp\'s stock, which

Question

Constant growth You are considering an investment in Keller Corp's stock, which is expected to pay a dividend of $2.25 a share at the end of the year (D_1 = $2.25) has a beta of 0.9. The risk-free rate is 5.2%, and the market risk premium is 6.0%. Keller currently sells for $32.00 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 P_3?) Round your answer to two decimal places.

Explanation / Answer

Answer: Expected return=Rf+beta*MArket risk premium

=5.2%+0.9*6%

=10.6%

Today Price =D0(1+g)/(k - g)

32=2.25(1+g)/(0.106-g)

32*(0.106-g)=2.25+2.25g

3.392-32g=2.25+2.25g

1.142=34.25g

g=0.03334

Price at end year 3 = D4/(k-g)
where D4 = D0* (1 + g)^4, and k = 0.106

=2.25*(1.03334)^4/(0.106-0.03334)

=35.31

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