Crisp Cookware\'s common stock is expected to pay a dividend of $2.25 a share at
ID: 2616031 • Letter: C
Question
Crisp Cookware's common stock is expected to pay a dividend of $2.25 a share at the end of this year (D1 = $2.25); its beta is 1.20. The risk-free rate is 5.3% and the market risk premium is 6%. The dividend is expected to grow at some constant rate gL, and the stock currently sells for $20 a share. Assuming the market is in equilibrium, what does the market believe will be the stock's price at the end of 3 years (i.e., what is )? Do not round intermediate steps. Round your answer to the nearest cent.
Explanation / Answer
Required return=Risk free rate+Beta*Market risk premium
=5.3+(1.2*6)=12.5%
Required return=(D1/Current price)+Growth rate
0.125=(2.25/20)+Growth rate
Growth rate=0.125-(2.25/20)
=1.25%
We use the formula:
A=P(1+r/100)^n
where
A=future value
P=present value
r=rate of interest
n=time period.
Hence
P3=$20*(1+1.25/100)^3
=$20*1.037970703
which is equal to
=$20.76(Approx).
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