A share of stock is now selling for $125. It will pay a dividend of $8 per share at the end of the year. Its beta is 1. What must investors expect the stock to sell for at the end of the year? Assume the risk-free rate is 7% and the expected rate of return on the market is 19%. (Round your answer to 2 decimal places.)

Investors must pay $140.75 for the share

Explanation:

Using Miller and Modgiliani CAPM formula, the return on the stock is calculated thus:

ERi =Rf +βi (ERm -Rf )

Rf is the risk-free rate of 7%

Beta is 1

(ERm -Rf ) = 19%-7%=12%

ERi=7%+1 (12%)

ERi=19%

the expected selling price can be computed using the below formula:

return on investment = (expected selling price+dividend) / current price+1

return on investment is 19%

dividend $8

current price $125

expected selling price is the unknown

0.19 = (expected selling price + $8) / $125+1

1.19 = (expected selling price + $8) / $125

1.19*$125=expected selling price + $8

expected selling price = (1.19*$125) - $8

=$140.75