Assume that CAPM is valid. A share of stock is now selling for $130. It will pay

Question

Assume that CAPM is valid. A share of stock is now selling for $130. It will pay a dividend of $6 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 portfolio is 20%. (Round your answer to 2 decimal places.)

Assume that CAPM is valid. A share of stock is now selling for $130. It will pay a dividend of $6 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 portfolio is 20%. (Round your answer to 2 decimal places.)

Explanation / Answer

Using CAPM, we first need to compute required return on the stock:

We have:

Rf = 4%

B= 1

Rm =20%

Er = Rf + (Rm-Rf) x B

     = 4% + (20%-4%)x1

     = 4%+16%

     = 20%

Price of the stock using zero growth formula:

P= Dividend/ Er

   = $6/ 0.20

   = $30 per share

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