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 2.7%, and the market risk premium is 4.5%. Justus currently sells for $27.00 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.

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

Using excel spread sheet to calculate

Expected Year end dividend(D1)	1.5
Beta coefficient	0.9
Risk free rate(rrf)	2.70%
Market risk premium(RPm)	4.5%
Current Stock Price(P0)	27
Calculate reuired return			Formulas
Required Return on common stock	6.75%		(=2.7%+0.9*4.5%)
Calculate constant growth			Formulas
Total Return on common stock	6.750%		6.75%
Expected Dividend yield	5.56%		(=1.5/27)
Expected capital gain yield	1.19%		(=6.75%-5.56%)
Calculate stock Price in 3 years P3
Number of Years	3
Calculate P3 using P0	27.98		(=27*(1+1.19%)^3
Alternative calculation
Calculate P3 using dividends	27.98		(=1.5*(1+1.19%)/(6.75%-1.19%)