Question

Epley Industries stock has a beta of 1.25. The company just paid a dividend of $.40, and the dividends are expected to grow at 5 percent. The expected return on the market is 12 percent, and Treasury bills are yielding 5.8 percent. The most recent stock price for the company is $75. a. Calculate the cost of equity using the DCF method. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) DCF method % b. Calculate the cost of equity using the SML method.

Answer 1

Answer:

A. 5.56%

B. 13.55%

Explanation:

In this question, we are asked to calculate the equity cost using the DCF method and the SML method

A. DCF approach

cost of equity =[ D0(1+growth )/ current price] +growth

= [.40 (1+.05) / 70 ] + .05

= [ .42 / 75] + .05

= .0056 +.05

= 0.0556 same as 5.56%

B)SML approach

Cost of equity = Rf +Beta (Rm-Rf)

= 5.8+ 1.25 (12 -5.8 )

= 5.8+ 1.25 *6.2

= 5.8 + 7.75

= 13.55%