Question

A stock with a beta of 1.2 just paid a dividend of $3.25 that is expected to grow at 7%. If the risk-free rate is 2% and the market risk premium is 5.5%, what should be the price of the stock in five years?

• A. $217.34

• B. $284.89

• C. $203.13

• D. $304.84

Answer 1

Given about a stock,

Last dividend paid D0 = $3.25

Expected growth rate = 7%

stock's beta = 1.2

Risk free rate Rf = 2%

Market risk premium MRP = 5.5%

So, using CAPM expected return on stock r is

r = Rf + beta*MRP = 2 + 1.2*5.5 = 8.6%

So, expected dividend of the firm in year 5 is

D5 = D0*(1+g)^5 = 3.25*1.07^5 = $4.558

So, stock price in 5 years using constant dividend growth model is

P5 = D5*(1+g)/(r-g) = 4.558*1.07/(0.086-0.07) = $304.84

So, option D is correct.