A share of stock is now selling for $130. It will pay a dividend of $6 per share

Question

A share of stock is now selling for $130. It will pay a dividend of $6 per share at the end of the year. Its beta is 1. What do investors expect the stock to sell for at the end of the year? Assume the risk-free rate is 4% and the expected rate of return on the market is 20%. (Round your answer to 2 decimal places.)

A share of stock is now selling for $130. It will pay a dividend of $6 per share at the end of the year. Its beta is 1. What do investors expect the stock to sell for at the end of the year? Assume the risk-free rate is 4% and the expected rate of return on the market is 20%. (Round your answer to 2 decimal places.)

Explanation / Answer

Equity Risk Premium = Market Return - Risk Free Rate

= 20 - 4 = 16%

Risk Free Rate = 4%

Beta = 1

Expected Return on stock = Risk-free rate + Equity risk premium * Beta for stock

= 4 + 1*16 = 20%

Current Price = Present Value of Future Payments
130 = 6*(1+i)^-1 + Sell Price*(1+i)^-1 where i=20%
Sell Price = 150

THUS, EXPECTED SELLING PRICE INCLUSIVE OF DIVIDEND IS $150
  

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