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, 1900-2017 (figures in percent per year) are as Follows. Average Premium (Extra return versus Treasury bills) (8) Average Annual Rate of Return (8) Portfolio Treasury bills Treasury bonds 3.8 5.3 1.5 Common stocks 11.5 7.7 a. What is the discount rate on the stock? (Enter your answer as a percent rounded to 2 decimal places.) Discount rate 9.80 % b. What price should she be willing to pay for the stock today? (Do not round intermedlate calculations. Round your answer to 2 decimal places.) Stock price
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, 1900-2017 (figures in percent per year) are as Follows. Average Premium (Extra return versus Treasury bills) (8) Average Annual Rate of Return (8) Portfolio Treasury bills Treasury bonds 3.8 5.3 1.5 Common stocks 11.5 7.7 a. What is the discount rate on the stock? (Enter your answer as a percent rounded to 2 decimal places.) Discount rate 9.80 % b. What price should she be willing to pay for the stock today? (Do not round intermedlate calculations. Round your answer to 2 decimal places.) Stock price
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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Transcribed Image Text: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, 1900-2017 (figures in percent per year) are as
follows.
Average Premium
(Extra return
versus Treasury
bills) ()
Average Annual
Rate of Return (Y
Portfolid
Treasury bills
Treasury bonds
Common stocks
3.8
5.3
1.5
11.5
7.7
a. What is the discount rate on the stock? (Enter your answer as a percent rounded to 2 decimal places.)
Discount rate
9.80 %
b. What price should she be willing to pay for the stock today? (Do not round intermedlate calculations. Round your answer to 2
decimal places.)
Stock price
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Step 1 Basic Details and Formula
a. Year End Stock price = $49.00
b. Dividend at End of the Year = $3.00
c. Discount rate on the stock = Risk Free Rate + Average premium
Discount rate on the stock = 2.10% + 7.70%
Discount rate on the stock = 9.80%
d. We have to use Discount Model to calculate the stock price i.e., Cash Flow at the end of year / (1 + Discount rate)
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