Hello frnds Plz solve this query which is based on constant growth valuation model.
ABC ltd's common stock is expected to pay a dividend of Rs 3 a share at the end of this year.
its beta is 0.8
the risk free rate is 5.2%
the market risk premium is 6%
dividend is expected to grow at some constant rate g,
and the stock currently sales for Rs 40 a share. assuming the market is in equilibrium what does the market believe will be the stock's price at the end of 3 year?
Solution to your query-
Given in Ques
Current MP=40 (P0), RF=5.2%, Beta=0.8, Market Risk Premium (Market Rate of Return-Rf)=6%, Expected Dividend(D1)=3
First of all calculate Ke by CAPM modle
Ke=Rf+beta*Market risk premium
i.e, 0.052+0.8*.06=0.1 or 10%
now calculate Growth rate
Ke=D1/P0+g
.1=3/40+g, g=0.025 or 2.5%,
then calculate markt price at the end of 3 yrs
P1=P0(1+g)
40(1+.025) raise to the power 3
P1=43.07 mkt price at the end of 3 yrs....
i thnk it must be correct...
CAclubindia
