The price of the stock should be $25.42.
A financial model used to determine an asset's expected rate of return is known as the capital asset pricing model (CAPM). The predicted returns on the market and a risk-free asset, as well as the asset's correlation with or sensitivity to the market, are used by CAPM to achieve this (beta). The CAPM has some drawbacks, such as relying on a linear interpretation of risk vs. return and making irrational assumptions. Despite its flaws, the CAPM formula is still often employed since it is straightforward and makes comparing different investment options simple.
It is given that beta is 1.2; risk free rate is 6%; and market premium is 9%.
According to CAPM,
expected return = risk-free rate + beta * risk premium
= 6% + 1.2*9%
=16.8%
It is also given that dividend for next year is $3 and growth rate is 5%.
To find the price of share, the formula used is:
= Dividend ÷ (expected return - growth rate)
= 3 ÷ (16.8% - 5%)
= 3÷ 11.8%
= 25.42
Thus, price of share is $25.42.
To know more about CAPM
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