Answer:
P0 = $42.4117 rounded off to $41.41
Explanation:
Using the constant growth model of dividend discount model, we can calculate the price of the stock today. The DDM values a stock based on the present value of the expected future dividends from the stock. The formula for price today under this model is,
P0 = D0 * (1+g) / (r - g)
Where,
D0 is the dividend paid recentl
D0 * (1+g) is dividend expected for the next period /year
g is the growth rate
r is the required rate of return or cost of equity
First we need to calculate the required rate of return on this stock using CAPM.
Using the CAPM, we can calculate the required rate of return on a stock. This is the minimum return required by the investors to invest in a stock based on its systematic risk, the market's risk premium and the risk free rate.
The formula for required rate of return under CAPM is,
r = rRF + Beta * (rM - rRF)
Where,
rRF is the risk free rate
rpM is the market return
r = 0.025 + 2 * (0.07 - 0.025)
r = 0.115 or 11.5%
Using the constant growth of dividend formula,
P0 = 3.5 * (1+0.03) / (0.115 - 0.03)
P0 = $42.4117 rounded off to $41.41
