Question

2. Boilermaker Corp has a beta of 0.8. The market return is expected to be 15%, and the current risk-free rate is 4%. We have used analysts’ estimates to determine that the market believes our dividends will grow at 5% per year and our last dividend was $1. The stock is currently selling for $12.00. What is the company’s cost of equity using the Security Market Line and using the Dividend Growth Model?

Answer 1

Answer:

Security Market Line 16%

Dividend Growth Model 13.75%

Explanation:

Boilermaker Corp

Security Market Line: Re = 4% + 0.8(15%)

=0.04+0.12

= 16%

Dividend Growth Model : Re = [1(1.05)/12.00] + 0.05

=1(0.0875)+0.05

=0.0875+0.05

= 13.75%

Therefore the company’s cost of equity using the Security Market Line is 16% and using the Dividend Growth Model is 13.75%