Question

A share of stock with a beta of 0.84 now sells for $69. Investors expect the stock to pay a year-end dividend of $4. The T-bill rate is 3%, and the market risk premium is 7%.a. Suppose investors believe the stock will sell for $71 at year-end. Calculate the opportunity cost of capital. Is the stock a good or bad buy? What will investors do? (Do not round intermediate calculations. Round your opportunity cost of capital calculation as a whole percentage rounded to 2 decimal places.)Opportunity Cost of Capital ________%?b. At what price will the stock reach an "equilibrium" at which it is perceived as fairly priced today? (Do not round intermediate calculations. Round your answer to 2 decimal places.)Stock price-__________________?

Answer 1

Answer:

Consider the following calculations

Explanation:

r=rf + B X (rm-rf)        

rf=3%          

B=0.84          

rm-rf=7%          

r=8.88%  

       

So, given the market risk premium and beta, the return should be 8.9% by above equation

 

If he buys the stock

         

Total return=Dividend+ capital appreciation  

   

4+(71-69)=6        

Return%=8.70%  (6/69)  

   

Opprtunity cost is 8.9% as given the beta of stock and market risk premium, 8.9% should be the return.

 

But, the above stock is expected to give only 8.7% return (dividend and capital gain), so he should not invest, bad buy.