Question

You are considering an investment in Justus Corporation's stock, which is expected to pay a dividend of $1.50 a share at the end of the year (D1 = $1.50) and has a beta of 0.9. The risk-free rate is 3.2%, and the market risk premium is 4.5%. Justus currently sells for $40.00 a share, and its dividend is expected to grow at some constant rate, g. Assuming the market is in equilibrium, what does the market believe will be the stock price at the end of 3 years? (That is, what is ?) Round your answer to two decimal places. Do not round your intermediate calculation

Answer 1

Answer:

44.35

Explanation:

The stock will increase the grow rate of the company. We need to solve this.

The grow rate will be determinate using the Gordon dividend grow model

$\frac{divends}{return-growth} = Intrinsic \: Value$

we clear for g

$return - \frac{divends}{stock} = grow$

to find the return we use CAPM

$Ke= r_f + \beta (r_m-r_f)$  

risk free 0.032

market rate

premium market = (market rate - risk free) = 0.045

beta(non diversifiable risk) = 0.9

$Ke= 0.032 + 0.9 (0.045)$

Ke 0.07250

this will be the return we use in the formula for grow

g = 0.0725 - 1.5/40 = 0.03500

At this rate our dividends will grow and also our share price

the stock in 3 years will be the current price capitalized with the grow rate

$Stock \: (1+ grow)^{time} = Stock_{3years}$

Stock    40.00

time 3.00

rate         0.035

$40 \: (1+ 0.035)^{3} = Stock_{3years}$

Futue value in 3 years = 44.35