Constant Growth Valuation Crisp Cookware\'s common stock is expected to pay a di
ID: 2643786 • Letter: C
Question
Constant Growth Valuation
Crisp Cookware's common stock is expected to pay a dividend of $2.5 a share at the end of this year (D1 = $2.50); its beta is 1.05; the risk-free rate is 4.8%; and the market risk premium is 5%. The dividend is expected to grow at some constant rate g, and the stock currently sells for $30 a share. Assuming the market is in equilibrium, what does the market believe will be the stock's price at the end of 3 years (i.e., P3 what is )? Do not round intermediate steps. Round your answer to the nearest cent.
Explanation / Answer
Step 1: Calculate the required rate of return: rs = rRF + (rM - rRF)b
RF is risk free return = 4.8%, Rm is market riisk premium = 5%, b= beta that is 1.05
= 4.8% + (5%)*1.05 = 10.05%
Use the constant growth rate formula to calculate g:
required rate of return = (D1/P0)+g
.1005 = (2.5/30)+g
g = .1005 - .08 = .017 = 1.7%
D4 = D1*(1+g)^3
= 2.5*1.05 = 2.63
Price of the stock is D4/K-g where k is required rate of return and g is growth rate
P3 = 2.63/( 0.1005 - 0.017)
=2.78/.083
=31.57
Price of the stock after 3 years would be $ 31.57