Question

urrently sells for $69.57 per share and has a beta of .91. The market risk premium is 7.40 percent and the risk-free rate is 2.97 percent annually. The company just paid a dividend of $3.69 per share, which it has pledged to increase at an annual rate of 3.40 percent indefinitely. What is your best estimate of the company's cost of equity?

Answer 1

Answer:

Using Capital Asset Pricing Model

Ke= Rf +β(Market risk-premium)

Ke = 2.97 + 0.91(7.40)

Ke = 9.9%

Using Dividend Growth Model

Ke = Do(1 + g) + g

               Po

Ke = $3.69(1 + 0.034)  + 0.034

                    $69.57

Ke = $3.69(1.034) + 0.034

                  $69.57

Ke = 0.0548  + 0.034

Ke = 0.089 = 9%

The best estimate of the company's cost of equity is 9.9%

Explanation:

Cost of equity is a function of risk-free rate plus the product of beta and market risk-premium according to capital asset pricing model.

Using dividend growth model, cost of equity is a function of current dividend paid, subject to growth rate, divided by current market price plus growth rate.