A company is expected to pay a dividend of $1.37 per share one year from now and

Question

A company is expected to pay a dividend of $1.37 per share one year from now and $1.84 in two years. You estimate the risk-free rate to be 4.2% per year and the expected market risk premium to be 5.9% per year. Analysts expect the price of the stock to be $58 per share in one year. The beta of the stock is 1.1, and the current price to earnings ratio of the stock is 12. What would be an appropriate estimate of the stock price to be today? (Answer to the nearest penny, i.e. 55.55 but do not use a $ sign).

Explanation / Answer

Required return (CAPM) = Rf+×Rp

Rf is risk free return

Rp is risk premium

= 4.2%+1.1×5.9%

= 10.69%

Stock price today:

= Present value of D1+Present value of P1

= ($1.37+$58)÷(1+10.69%)

= $53.64

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