A share of stock with a beta of 079 now sells for $61. Investors expect the stoc

Question

A share of stock with a beta of 079 now sells for $61. Investors expect the stock to pay a year-end dividend of $3. The T-bill rate is 6% and the market risk premium is 9%. a. Suppose investors belileve the stock will sell for $63 at year-end. Is the stock a good or bad buy? What will Investors do? The stock is a buy and the b. At what price will the stock reach an "equillbrium" at which it is perceivedas fairly priced today? (Do not round Intermediate calculations. Round your answer to 2 decimal places.)

Explanation / Answer

Beta of the stock 0.79 Current stock price 61 Year end dividend 3 T-Bill rate 6% Market risk premium 9% Based on CAPM the ROE of the stock Required return 13.11% T-Bill rate + Beta*Market risk premium a Expected stock price at year end 63 Return from stock 5 Capital gains plus dividend Percentage return 8.20% Since the stock is giving only 8.2% return which is lower than the required return of 13.11% so the stock is a bad buy and investors would not buy it b Based on the dividend discount model Stock price 69.00 Using the required return

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