Question

A share of stock with a beta of 1.2 now sells for $100. Investors expect the stock to pay a year-end dividend of $1.50. The treasury bill rate is 5 percent and the expected rate of return on the market portfolio is 12 percent. If the stock is perceived to be fairly priced today, what must be investors’ expectation for the price of the stock at the end of the year?

$109.50

$111.90

$116.50

$117.90

$106.90

Answer 1

Required rate of return = Rsk-free rate + [beta * (risk-premium)]

= 5% + [1.20 * (12% - 5%)

= 13.40%

Expected dividend (D1) = $1.50

P1 = P0 * (1 + 0.134) - D1

P1 = $100 * (1.134) - $1.50

P1 = $111.90

Price of stock at the end of the year = $111.90