Assume that CAPM is valid. A share of stock is now selling for $105. It will pay

Question

Assume that CAPM is valid. A share of stock is now selling for $105. It will pay a dividend of $7 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 7% and the expected rate of return on the market portfolio is 16%. (Round your answer to 2 decimal places.)

Assume that CAPM is valid. A share of stock is now selling for $105. It will pay a dividend of $7 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 7% and the expected rate of return on the market portfolio is 16%. (Round your answer to 2 decimal places.)

Explanation / Answer

CAPM = Risk Free Rate + Beta(Market Return - Risk Free Rate)

= 7 + 1 * ( 16-7) = 16%

Po(price today) = $ 105

Price at year end = 105 * 1.16 = (Since 16% is the required return) = $121.80

Dividends paid have a reducing effect on the value of stock. So after dividend is paid, the value of the stock falls by the dividend amount. This is logical because the value of a stock is derived from the assets of the company and as soon as dividend is paid, cash is reduced which will lead to fall in stock price

So revised Stock price = 121.80 - 7 = $114.80

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