The company's common stock is going to pay a dividend is $2.00 per share after one year. Dividends are expected to grow at 10 percent per year for 2 years after that ($2.20 two years from now, and $2.42 3 years from now), and 4% thereafter. The expected market return is 6%, your stock has a beta of 1.2. The return on riskless government bonds is 2%.
1. Assuming CAPM is correct, what should be the price of the stock?
2. Suppose the market price of the stock is $30 (different from the price that CAPM says it should be), what would you tell the investors about investing in the stock?