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A stock is not expected to pay a dividend over the next 4 years
A stock is not expected to pay a dividend over the next 4 years. Five years from now the company anticipates that it will establish a dividend of $1 a share (D5=$1). Once the dividend is established, the market expects that the dividend will grow at a constant rate of 5% per year for the indefinite future. The risk-free rate is 5%, the company's beta is 1.2, and the market risk premium is 5%. The required rate of return on the company's sock is expected to remain constant. What is the current stock price?
Expert Solution
Computation of Ke
Rf= Risk free Rate= 5.00%
Km= Expected market return=10.0%
b=beta coefficient=1.2
Ke = Rf+b(Km-Rf)=11.00%
Price in year 4= D5/(ke-g)=16.67
D5=1, Ke=11%, g=5%
Present value= 16.67/(1+.11)^4=10.98
P4/(1+ke)^4
Thus current stock price= $10.98.
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