You are considering purchasing shares of GreenGro, a supplier of fresh produce. The stock just paid a dividend of $1.42 and dividends are expected to grow after that at an annual rate of 2%, forever. The stock has a correlation with the overall market of 0.70. The standard deviation of the stock’s returns is 0.60 and the standard deviation of the overall market’s returns is 0.375. The yield on T- Bills is 3%, and the return on the market portfolio is expected to be 11.5%.

a) What should be the price of the stock assuming that the Capital Asset Pricing model is true?

b) Suppose the stock is selling in the market at a price of $14.10, is it over-valued or under-valued? Explain what should happen to the stock price if the market is efficient.

Answer rating: 100% (QA)

a Using CAPM model we need to calculate s beta of stock to find the required rate of retur... View the full answer