You are considering an investment in Crisp\'s Cookware\'s common stock. The stoc

Question

You are considering an investment in Crisp's Cookware's common stock. The stock is expected to pay a dividend of $2 a share at the end of the year (D1 = $2.00); its beta is 0.95; the risk-free rate is 3.1 %; and the market risk premium is 4%. The dividend is expected to grow at some constant rate g, the stock currently sells for $26 a share. Assuming the market is in equilibrium, what does the market believe will be the stock price at the end of 3 years (i.e., what is P??3 )? Round your answer to the nearest cent.

Explanation / Answer

We first calculate the growth rate g
Using the dividend disoc**t model
P0 = D1/(Ke-g)
Here
P0 = current market price = $26
Ke = reruired return, which we can calculate using the CAPM equation
Required return = Rf + (Rm-Rf) X beta = 3.1% + 4%X0.95 = 6.9 %
D1 = expected dividend = $2.00
We get
26 = 2/(6.9%-g)
Solving gives g as 6.823 %

Growth rate g is the capital gains yield implying that the stock price will increase by this growth rate
Price at the end of three years P3 = P0 X (1+g)^3 = 26 X (1+6.823 %)^3 = $31.7

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