Question

A share of stock with a beta of 0.70 now sells for $60. Investors expect the stock to pay a year-end dividend of $4. The T-bill rate is 5%, and the market risk premium is 8%.

A. At what price will the stock reach an “equilibrium” at which it is perceived as fairly priced today? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Stock Price: __________

Answer 1

Dividend next year =   $4  
Current price=   $60  

Cost of Equity as per CAPM = Risk free rate + (Beta*market risk premium)      
5% + (0.7*8%)=   10.60%  

Current price (P0) formula = (D1+P1)/(1+ke)      
60 =   (4+P1)/(1+10.60%)  
60*1.106= 4+P1      
P1=   66.36 -4
P1=   62.36  
      
So stock equilibrium price in year 1 is $62.36, where it will be perceived to be failrly priced.