Question

You are considering an investment in Keller Corp's stock, which is expected to pay a dividend of $1.00 a share at the end of the year and has a beta of 0.50. The risk-free rate is 2.50%, and the market risk premium is 4.50%. Keller currently sells for $104.00 a share, and its dividend is expected to grow at some constant rateg. Assuming the market is in equilibrium, what does the market believe will be the stock price at the end of 5 years?

Answer 1

As per CAPM,

Required return = risk free rate + beta*market risk premium

= 2.50 + 0.5*4.5

= 4.75%

Share Price = D1/(required return - g)

104 = 1/(4.75%-g)

4.94 - 104g = 1

104g = 3.94

=3.79%

so Market Price after 5 years = current Price*(1+g)^5

= 104*(1+3.79%)^5

= 104*1.20433

=$125.25

Thanks