Question

Crisp Cookware's common stock is expected to pay a dividend of $2.5 a share at the end of this year (D1 = $2.50); its beta is 0.7. The risk-free rate is 4.8% and the market risk premium is 5%. The dividend is expected to grow at some constant rate g, and the stock currently sells for $40 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 calculations. Round your answer to the nearest cent.

Answer 1

first we need to find the growth rate:

as per dividend growth model:

price of a stock = D1 / (k-g)

here,

price = $40

D1=$2.50

k = risk free rate + beta*(market risk premium)

=>4.8% + 0.70*(5%)

=>8.3%

g = to be found out

=> 40 = $2.50 / (0.083 - g)

=>3.32-40g = 2.50

=>0.82 =40g

=>g = 0.82/40

=>g=0.0205

=>g=2.05%

now,

stock price at the end of 3 years

=> P3 = current stock price *(1+g)^3

=>$40*(1.0205)^3

=>$42.51

so the stock price at the end of 3 years will be = $42.51.