You are considering buying 100 shares of Cruzer Corpcommon s

You are considering buying 100 shares of Cruzer Corp.common stock. The common stock is expected to pay a dividend of $3.50 a year from today; the growth rate of the dividends is 4%; the covariance between Cruzer’s’s return and the marker’s return is expected to be 0.003; the variance of the market’s return is expected to be 0.002. It is also estimated that the return on the TSX/S&P is 15% and the return on government of Canada T-Bills is 7%. Should you buy the shares if the current market price of Cruzer’s common stock is $21.00? Show your work.

Solution

beta of stock = 0.003/0.002 = 1.5

required return on the stock = 7% + 1.5*(15% - 7%) = 19%

value of the stock = 3.50/(0.19 - 0.04) = 23.33

since the stock is undervalued you should buy