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 $1.75 a share at the end of the year (D₁ = $1.75) and has a beta of 0.9. The risk-free rate is 5.3%, and the market risk premium is 4.5%. Justus currently sells for $46.00 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

As Excel is not attached, I am providing the screen shots of excel where I have worked. We can't attach excels in answers.

Required Ret:

CAPM Ret = Rf + Beta ( Rm - Rf )

Rf = Risk free ret
Rm = Market ret
Rm - Rf = Risk Premium
Beta = Systematic Risk

Particulars	Amount
Risk Free Rate	5.300%
Market Return	9.800%
Beta	0.9000
Risk Premium ( Rm - Rf)	4.50%

Beta Specifies Systematic Risk. Systematic risk specifies the How many times security return will deviate to market changes. SML return considers the risk premium for Systematic risk alone.Where as CML return considers risk premium for Total risk. Beta of market is "1".

SML Return = Rf + Beta ( Rm - Rf )
= 5.3 % + 0.9 ( 4.5 % )
= 5.3 % + ( 4.05 % )
= 9.35 %

Rf = Risk Free Rate

Growth rate:

Particulars	Amount
D1	$   1.75
Required Ret	9.35%
Price	$ 46.00

g = Ke - [ D1 / P0 ]
= 0.0935 - [ 1.75 / 46 ]
= 0.0935 - 0.04
= 0.0555
I.e Growth Rate is 5.55 %

Where

D1 = Expected Div after 1 Year
P0 = Price Today
Ke = Required Ret
g = Growth Rate

Price after 3 Years:

P3 = D4 / [ Ke - g ]

D4 = D1 ( 1 +g )^3

= $ 1.75 * ( 1 + 0.0555)^3

= $ 1.75 ( 1.0555 ^ 3 )

= $ 1.75 * 1.1759

= $ 2.06

Particulars	Amount
nth Period	4
D4	$             2.06
Growth rate	5.55%
Ke	9.35%

Price of Stock is nothing but PV of CFs from it.
P3 = D4 / [ Ke - g ]
= $ 2.06 / [ 9.35 % - 5.55 % ]
= $ 2.06 / [ 3.8 % ]
= $ 54.15

Price after 3 Years is $ 54.15