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%.

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.)

( The answer is not $27.47)

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%.

Explanation / Answer

Answer:a

Opportunity cost of capital =(5%+0.74*8%)= 10.92%

Expected return (%) = (3+(52-20))/50=10%

Expected return is less than the opportunity cost of capital.

The stock is a bad buy and the investors will not invest

Answer:b The correct price should be

($52– P)/P + $3/P = 10.92%

55-P=0.1092P

1.1092P=55

=> P = $49.58

Fair" price of the stock = $49.58

This is less than the current price. Investors will want to sell the stock, in the process reducing its price until it reaches $49.58

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