A share of stock with a beta of .85 now sells for $58. Investors expect the stoc

Question

A share of stock with a beta of .85 now sells for $58. Investors expect the stock to pay a year-end dividend of $2. The T-bill rate is 4%, and the market risk premium is 7%.

At what price will the stock reach an “equilibrium” at which it is perceived as fairly priced today? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

A share of stock with a beta of .85 now sells for $58. Investors expect the stock to pay a year-end dividend of $2. The T-bill rate is 4%, and the market risk premium is 7%.

Explanation / Answer

a. Required rate of return = 4% + 0.85 * 7%

= 9.95%

Now,

$58 = $2 / (9.95% - growth rate)

=> growth rate = 6.50%

One year hence, the stock value = $2 * (1+6.50%) / (9.95%-6.50%)

= $61.74

So, the stock is a bad buy and the investors will not invest.

b. Stock price = $61.74

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