A share of stock with a beta of 0.74 now sells for $50. Investors expect the sto

Question

A share of stock with a beta of 0.74 now sells for $50. Investors expect the stock to pay a year-end dividend of $3. The T-bill rate is 5%, and the market risk premium is 8%. a. Suppose investors believe the stock will sell for $52 at year-end. Is the stock a good or bad buy? What will investors do? The stock is a buy and the investors 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

Ans a.

According to CAPM model,

The required rate of return on stock = 5 + 0.74*8 = 10.92%

On purchasing and selling of stock,

The holding period return = 3 + (52 - 50) / 50 = 5/50 =10%

Since the reuired rate of return is higher than the return generated on stock,

Therefore, the stock is bad and investor shouldn't but the stock.

Ans b

THe equilibirium price is suppose X

Therefore, 3 + (X - 50) / 50 = 10.92%

3 + (X - 50) = 5.46

X - 50 = 2.46

X = 52.46

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