Question

Problem 5:

A share of stock sells for $100 today. It will pay a dividend of $6 per share at the end of the year. Its beta is 0.8. What do investors expect the stock to sell for at the end of the year? The risk-free rate of interest is 4% and the expected rate of return on the market is 12%

Answer 1

The price at the end of the year is computed as shown below:

( Price at end – current price + dividend ) / current price = Required rate of return

Required rate of return = Risk free rate + Beta ( Return on market – Risk free rate )

= 0.04 + 0.8 ( 0.12 – 0.04 )

= 0.104 or 10.4%

So the price at end of year will be

= ( Price at end - $ 100 + $ 6 ) /$ 100 = 0.104

Price at end = $ 104.40

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