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 $2.00 a share at the end of the year (D₁ = $2.00) and has a beta of 0.9. The risk-free rate is 3.8%, and the market risk premium is 4.5%. Justus currently sells for $42.00 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.

Open spreadsheet

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

Required Return = Risk-free Rate + Beta * Market Risk Premium
Required Return = 3.80% + 0.90 * 4.50%
Required Return = 7.85%

Required Return = Expected Dividend / Current Price + Growth Rate
0.0785 = $2.00 / $42.00 + Growth Rate
0.0785 = 0.0476 + Growth Rate
Growth Rate = 0.0309 or 3.09%

Stock Price in 3 years = Current Price * (1 + Growth Rate)^3
Stock Price in 3 years = $42.00 * 1.0309^3
Stock Price in 3 years = $42.00 * 1.09559
Stock Price in 3 years = $46.01