A share of stock is now selling for $110. It will pay a dividend of $8 per share

Question

A share of stock is now selling for $110. It will pay a dividend of $8 per share at the end of the year. Its beta is 1. What do investors expect the stock to sell for at the end of the year? Assume the risk-free rate is 4% and the expected rate of return on the market is 15%. (Round your answer to 2 decimal places.)

A share of stock is now selling for $110. It will pay a dividend of $8 per share at the end of the year. Its beta is 1. What do investors expect the stock to sell for at the end of the year? Assume the risk-free rate is 4% and the expected rate of return on the market is 15%. (Round your answer to 2 decimal places.)

Explanation / Answer

Cost of equity =Rf +beta(market return -Rf)

                   = 4 + 1 (15 -4)

                   = 4   + 1 *11

                   = 4 +11

                  = 15%

current selling price =dividend /(cost of equity-g)

                        110        = 8 / (.15- g)

                          .15-g = 8/110

                           .15- g = .07273

                            .15- .07273 = g

                             g = .0773 or 7.73%

D2 = 8 (1 + .0773) = 8.6184

Price at end of 1 year =D2 /(Cost -g)

                          = 8.6184 / (.15- .0773)

                         = 8.6184 / .0727

                         = $ 118.55 per share

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