A share of stock with a beta of .66 now sells for $48. Investors expect the stoc
ID: 2766538 • Letter: A
Question
A share of stock with a beta of .66 now sells for $48. Investors expect the stock to pay a year-end dividend of $2. The T-bill rate is 5%, and the market risk premium is 8%.
a. Suppose investors believe the stock will sell for $50 at year-end. Is the stock a good or bad buy? What will investors do?
The stock is a (good or bad???) buy and the investors (will invest or will not invest???)
b. At what price will the stock reach an “equilibrium” at which it is perceived as fairly priced today? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
Stock price?
Explanation / Answer
Risk free rate = 5%
Risk Premium = 8%
Beta = 0.66
Expected rate of return is calculated below using CAPM formula:
Expected rate of return = Risk free rate + Risk Premium × Beta
= 5% + 8% × 0.66
= 5% + 5.28%
= 13.28%
Hence, required rate of return of company stock is 12.08%.
Current stock Price = $48
Expected dividend = $2
Expected stock price after one year = $50
Expected return on investment in stock = [$2 + ($50 - $48)] / $48
= $4 / $48
= 8.33%
Required rate of return on stock is 13.28% and expected rate of return is 8.33%. So it is not a good to buy stock of company.
Again
Stock price at which investor can purchase stock = [$48 × (1 + 13.28%] - $2
= $64.375 -$2
= $52.375
If stock price next year is $52.375 or more than it is good investment. Minimum stock price next year to invest in stock is $52.375.
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.