At 11:25 AM, the stock price of Fred’s Flour Company was $40. At 11:26 AM, the company issued a press release. Following this press release, investors revised their expectations, and now expect the company to pay a $0.45 dividend one year from today and for its stock price to be $41.50 immediately after that dividend payment. The risk free rate is 4%, the return on the market is 9%, and the company’s Beta is 1.3.
A. What is the required return on Fred’s Flour Company stock?
B. Following this announcement, how much do rational investors think the each share of stock is worth? (Hint: Investors now expect the company to pay a $0.45 dividend one year from today and for its stock price to be $41.50 immediately after that dividend payment).
C. Will the stock price increase or decrease after the news release? If the market is efficient, how long (approximately) will it take for the price to adjust?