Question

It will pay a dividend of $7 per share at the end of the year. its beta is 1.0. What must investors expect the stock to sell for at the end of the year?

Answer 1

The answer is $\ 114.8$

Calculate the expected return using CAPM approach as follows:

$\begin{aligned}\text { Expected return } &=\text { Risk-free rate }+\text { Beta } \times(\text { Return on market portfolio }-\text { Risk-free rate }) \\&=7 \%+1 \times(16 \%-7 \%) \\&=7 \%+9 \% \\&=16 \%\end{aligned}$

How to calculate the price at the end of the year?

Price at the end of year = Price today $\times(1+$ Expected return $)$

$\begin{aligned}&=\ 105 \times(1+0.16) \\&=\ 121.8\end{aligned}$

The dividend is deducted from the price at the end of year as after the dividend declaration the stock price tend to reduce. Calculate the expected selling price of share as follows:

Expected selling price = Price at the end of year - Dividend

$\begin{aligned}&=\ 121.8-\ 7.0 \\&=\ 114.8\end{aligned}$

Therefore, the expected selling price of share is $\ 114.8$.

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