Question

Constant Growth Valuation Crisp Cookware's common stock is expected to pay a dividend of $1.75 a share at the end of this year (D1 = $1.75); its beta is 1.15; the risk-free rate is 3.8%; and the market risk premium is 5%. The dividend is expected to grow at some constant rate g, and the stock currently sells for $21 a share. Assuming the market is in equilibrium, what does the market believe will be the stock's price at the end of 3 years (i.e., what is )? Do not round intermediate steps. Round your answer to the nearest cent.

Answer 1

Using CAPM model,

Required Rate = R_f + Beta(R_m - R_f)

R_f = 3.8%

Beta = 1.15

Risk Premium (R_m - R_f) = 5%

Required Rate = 3.8 + 1.15(5)

Required Rate = 9.55%

Using Dividend Discount Model,

Price = D₁/(r - g)

D₁ = 1.75

Price = $21 per share

r = 9.55%

g = 0.0955 - 1.75/21

g = 1.167%

Stock Price at the end of 3 years = D₄/(r - g)

D₄ = 1.75(1.0167)(1.0167)(1.0167)

D₄ = $1.839

Stock Price at Year 3 end = 1.839/(0.0955 - 0.01167)

Stock Price at the end of Year 3 = $21.937