Newburn Entertainment's stock is expected to pay a year-end dividend of $3.00 a share. (D1 = $3.00, the dividend at time 0, D0, has already been paid.) The stock's dividend is expected to grow at a constant rate of 5 percent a year. The risk-free rate, rRF, is 6 percent and the market risk premium, (rM - rRF), is 5 percent. The stock has a beta of 0.8. What is the stock's expected price five years from now?
A) $60.00
B) $76.58
C) $96.63
D) $72.11
E) $68.96

Question

Quizplus · Accepted Answer

The correct answer is B. The expected price of the stock five years from now can be calculated using the Gordon Growth Model:P5 = D6 / (r - g)where:D6 is the expected dividend at the end of year 6r is the required rate of returng is the expected growth rate of the dividendThe expected dividend at the end of year 6 can be calculated as follows:D6 = D1 * (1 + g)^5= $3.00 * (1 + 0.05)^5= $3.48The required rate of return can be calculated using the Capital Asset Pricing Model (CAPM):r = rRF + beta * (rM - rRF)= 0.06 + 0.8 * 0.05= 0.10The expected price of the stock five years from now can now be calculated as follows:P5 = D6 / (r - g)= $3.48 / (0.10 - 0.05)= $76.58

Newburn Entertainment's Stock Is Expected to Pay a Year-End Dividend