Problem 9-13 Constant growth You are considering an investment in Justus Corpora

Question

Problem 9-13 Constant growth You are considering an investment in Justus Corporation's stock, which is expected to pay a dividend of $2.00 a share at the end of the year (D1 = $2.00) and has a beta of 0.9. The risk-free rate is 5.1%, and the market risk premium is 6.0% Justus currently sells for $28.00 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 Ps?) Round your answer to two decimal places. Do not round your intermediate calculations.

Explanation / Answer

Required return=Risk free rate+Beta*Market risk premium

=5.1+(0.9*6)

=10.5%

Required return=(Dividend for next period/Current price)+Growth rate

0.105=(2/28)+Growth rate

Hence Growth rate=0.105-(2/28)

=0.033571428

Hence stock price at end of 3 years=Current price(1+Growth rate)^3

=$28(1.033571428)^3

=$30.92(Approx)

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