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ss ses 120&nbld-881 585&snapshotid-881585&id-34154...- Homework i. d Course Materials M McGraw-Hill Connect are M McGraw-Hill Connect O how to create phot- MINDTAP um Cengage End-of-Chapter Problems-Basic Stock Valuation ssignment: Ch 08: End-of-Chapter Problems-Basic Stock Valuation Search this course Assignment Score: 37.50% Save Submit Assignment for Grading uestions Question 4 ofB Check My Work (No more tries available) eBook Problem Walk-Through Constant Growth Valuation risk premium is 6%. The dividend is expected to grow at some does the market belileve will be the stock's price at the end of 3 years (i.e, what is Ps)? Do not round intermediate ca OGrisp Cookware's common stock is expected to pay a dividend of $2 a share at the end of this year (D $2.00); its beta constant rate g, and the stock currently sells for $40 a share. Assuming the market is in equilbrium, what lculations. Round your answer to the nearest cent. 49.07 Hide Feedback Incorreet Check My Work No more tries available)Explanation / Answer
Stock Beta = 0.6, Risk-Free Rate = 3.5 %, Market Risk Premium = 6 %
Using Capital Asset Pricing Model:
Cost of Equity = Risk-Free Rate + Stock Beta x Market Risk Premium = 3.5 + 0.6 x 6 = 7.1 %
D1 = $ 2 and let the growth rate be g. Current Stock Price P0 = $ 40
Further, as the market is said to be in equilibirum, it essentially implies that the present value of the perpetually and constantly growing dividend stream at say T (because dividend is said to grow at a constant rate of g) should be equal to the stock price at T.
Therefore, P0 = D1 / (Cost of Equity - g)
g = Cost of Equity - (D1/P0) = 0.071 - (2/40) = 0.021 or 2.1%
As already mentioned above the stock price at any point should be equal to the present value of the perpetually and constantly growing dividend stream at that point of time. If the point in time is t=3 (as we need to determine P3), the present value of all dividends post t=3 should be equal to the market estimate of the stock's price at t=3.
Therefore. P3 = D4 / (Cost of Equity - g)
D4 = D1 x (1.021)^(3) = $ 2.1287 approximately. (the power is three because the interval between D1 and D4 is three years)
Therefore, P3 = 2.1287 / (0.071 - 0.021) = $ 42.5733 ~ $ 42.57 approximately.
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