Crisp Cookware's common stock is expected to pay a dividend of $2.5 a share at the end of this year (D1 = $2.50); its beta is 0.95; the risk-free rate is 4.7%; and the market risk premium is 6%. The dividend is expected to grow at some constant rate g, and the stock currently sells for $35 a share. Assuming the market is in equilibrium, what does the market believe will be the stock's price at the end of 3 years (i.e., what is )? Do not round intermediate steps. Round your answer to the nearest cent.
Solution:
Calculation of cost of equity(ke) as per CAPM
Ke=Risk free rate+beta(Market risk premium
=4.7%+(0.95*6%)
=10.40% or 0.104
Current share price(P0)=$35
D1=$2.50
We know that,
P0=D1/(ke-growth rate)
Growth rate=Ke-(D1/P0)
=0.1040-($2.50/$35)
=0.0326
=3.26%
Thus stock price at the end of 3rd year=P0(1+growth rate)^3
=$35(1+0.0326)^3
=$38.54
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