Question

Excel Online Structured Activity: Constant growth

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 5.6%, and the market risk premium is 5.5%. Justus currently sells for $40.00 a share, and its dividend is expected to grow at some constant rate, g. The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the question below.

Open spreadsheet

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 calculations.

Answer 1

SOLUTION:
DIVIDEND(D1)=$1.50
BETA=0.9
RISK FREE RATE =5.6%
MARKET RISK PREMIUM=5.5%
SELLING PRICE $40 PER SHARE(P0)
REQUIRED RATE OF RETURN(ke)=Rf+(Beta*Market risk premium)
			ke=5.6%+(0.9*5.5%)
			0.1055	or 10.55%
DIVIDEND GROWTH RATE:
COST OF EQUITY(Ke)=(D1/P0)+g
	10.55%=	(1.5/40)+g
	0.1055=	0.0375+g
	g=0.1055-0.0375
	0.068	or 6.8%
Calculation of stock price at the end of 3 years:
Stock price=Current share price*(1+g)3
	40*(1+0.068)*(1+0.068)*(1+0.068)
	48.72746	or 48.72 per share
THE stock price at the end of 3 years will $48.72