Top hedge fund manager Sally Buffit believes that a stock with the same market r

Question

Top hedge fund manager Sally Buffit believes that a stock with the same market risk as the S&P 500 will sell at year-end at a price of $49. The stock will pay a dividend at year-end of $3.00. Assume that risk-free Treasury securities currently offer an interest rate of 2.1%.

Average rates of return on Treasury bills, government bonds, and common stocks, 1900–2015 (figures in percent per year) are as follows.

What is the discount rate on the stock? (Enter your answer as a percent rounded to 2 decimal places.)

What price should she be willing to pay for the stock today? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Portfolio Average Annual
Rate of Return (%) Average Premium (Extra return
versus Treasury bills) (%) Treasury bills 3.8 Treasury bonds 5.3 1.5 Common stocks 11.4 7.6

Explanation / Answer

Discount rate on stock = Rf+ Beta*Risk premium

= 2.1%+ 1*7.6% = 9.7%

Price of the stock today = (P1+D1)/(1+k)

= (49+3)/1.097

=$47.4

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