A share of stock with a beta of 0.76 now sells for $51. Investors expect the stock to pay a year-end dividend of $2. The T-bill rate is 3%, and the market risk premium is 7%.
a. Suppose investors believe the stock will sell for $53 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.)
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.)
| a) | Opportunity cost of capital per CAPM = 3%+0.76*7% = | 8.32% |
| Expected return = (2+53-51)/53 = | 7.55% | |
| As the expected return is less than the opportunity cost | ||
| investors will not invest in this stock. Those who hold | ||
| the stock will sell it. | ||
| b) | Equilibrium price is that which is found out by discounting the expected cash flows with the OCC = (2+53)/1.0832 = | $ 50.78 |
A share of stock with a beta of 0.76 now sells for $51. Investors expect the stock to pay a year-...