A share of stock with a beta of .74 now sells for $50. Investors expect the stoc

Question

A share of stock with a beta of .74 now sells for $50. Investors expect the stock to pay a year-end dividend of $3. The T-bill rate is 5%, and the market risk premium is 8%. a. Suppose investors believe the stock will sell for $52 at year-end. Is the stock a good or bad buy? What will investors do?

The stock is a good/bad buy and the investors will/willnotinvest? .

b. 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.)

Stock price $

Explanation / Answer

future appreciation, it is a bad buy decision. Thus, investors will not invest

$27.47 per share is the equilibrium price at which demand and supply would match each other

Stock Price = Dividend at the end of year 1 / rate of return Required rate of return = Risk Free rate + Beta * Risk Premium 10.9200% = 5%+0.74*8% Stock price 27.47253 =3/10.92% The intrincsic value of stock is only $27.47. Hence, if we buy now at $50 expecting

future appreciation, it is a bad buy decision. Thus, investors will not invest

$27.47 per share is the equilibrium price at which demand and supply would match each other

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