Question

You consider buying a share of stock at a price of $31. the stock is expected to pay a dividend of $2.58 next year, and your advisory service tells you that you can expect to sell the stock in 1 year for $34. the stock's beta is 0.8, rf is 5%, and e[rm] = 15%. what is the stock's abnormal return?

Answer 1

im not sure but I need the points man

Answer 2

Assuming the stock is expected to pay a dividend of $2.58 next year, and your advisory service tells you that you can expect to sell the stock in 1 year for $34. Stock's abnormal return is 5%.

Stock's abnormal return

capital gain = $34- $31 = $3

Dividend = $2.58

Return on the Investment = $3 + $2.58 = $5.58

Percentage = 5.58/31×100 = 18%

Using the CAPM;

Ke=RF+Bi(ERm−RF)

Where:

Ke is the Cost of Equity

RF is the Risk-free rate of return

Bi is the beta of the stock

ERm is the Expected return from the Market

Ke = 5% + 0.8(15% - 5%)

Ke = 5% + 8%

Ke= 13%

Abnormal return = 18% - 13%

Abnormal return = 5%

Inconclusion stock's abnormal return is 5%.

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