Stock in Country Road Industries has a beta of 0.85. The market risk premium is
ID: 2619652 • Letter: S
Question
Stock in Country Road Industries has a beta of 0.85. The market risk premium is 8.5 percent, and T-bills are currently yielding 4 percent. The company's most recent dividend was $1.8 per share, and dividends are expected to grow at a 4.5 percent annual rate indefinitely. If the stock sells for $33 per share, what is your best estimate of the company's cost of equity? (Do not round your intermediate calculations.)
9.21%
10.2%
11.23%
7.83%
10.71%
Stock in Country Road Industries has a beta of 0.85. The market risk premium is 8.5 percent, and T-bills are currently yielding 4 percent. The company's most recent dividend was $1.8 per share, and dividends are expected to grow at a 4.5 percent annual rate indefinitely. If the stock sells for $33 per share, what is your best estimate of the company's cost of equity? (Do not round your intermediate calculations.)
9.21%
10.2%
11.23%
7.83%
10.71%
Explanation / Answer
Ans:- 10.71%
Calculations:-
a) AS per CAPM model,
Required return = Rf+Beta*(Rm-Rf)
Where ,
Rf= risk free rate = 4%
Beta= 0.85
Rm-Rf= Market risk premium = 8.5%
Substituting the values ,
Required return =4%+0.85*8.5%= 11.225%
Hence as per CAPM model cost of equity = 11.225%
b) As per dividend growth model
Price of share =[ DPSo*(1+g)]/(ke-g)
Where
Price of share = $33
DPS0= $1.80
Ke= Cost of equity
g= growth rate = 4.5%
Substituting the values,
33=1.80*1.045/(ke-0.045)
Ke-0.045=1.881/33
ke=0.057+0.045
ke=0.102 i.e. 10.20%
The cost of capital as per dividend growth model = 10.20%
c) The best estimate would be the average of both =(11.225%+10.20%)/2
=10.71%
Please feel free to ask if you have any query in the comment section.
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