Question

In: Accounting

Crisp Cookware's common stock is expected to pay a dividend of $2 a share at the end of this year (D1 $2.00); its beta is 0.8.

Crisp Cookware's common stock is expected to pay a dividend of $2 a share at the end of this year (D1 $2.00); its beta is 0.8. The risk-free rate is 5.3% and the market risk premium is 6%. The dividend is expected to grow at some constant rate, gL, and the stock currently sells for $50 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?

Expert Solution

Computation of the price of stock after 3 years is shown as follows:

Information given in question:

D₁ = $2.00

Beta = 0.8

Risk free rate = 5.3%

Market risk premium = 6%

Current price (i.e. P₀) = $50

Ke(Cost of equity) as per CAPM = risk free rate + beta * market risk premium

= 5.3% + 0.8 * 6%

= 5.3% + 4.8%

= 10.1%

Ke = (D₁ / P₀ ) + g

10.1% = ($2 / $50) + g

10.1% = 4% + g

Hence “g” or growth = 10.1% – 4%

= 6.1%

Stock price at the end of 3 years is:

P₃ = D₄ / (Ke – g)

= $2 * (1 + 6.1%)³ / (10.1% – 6.1%)

= $2 * (1.061)³ / 4%

= $2.3887 / 4%

= $59.71

ekkarill92 answered 2 years ago

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