Eaton Electronic Companys treasurer uses both the capital asset pricing model an

Question

Eaton Electronic Companys treasurer uses both the capital asset pricing model and the dividend valuation model to compute the cost of common equity (also referred to as the required rate of return for common equity). Assume:

Rf = 3 %

Km = 6 %

= 1.5

D1 = $ .60

P0 = $ 21

g = 7 %

(a) Compute Ki (required rate of return on common equity based on the capital asset pricing model). (Round your final answers to 2 decimal places. Omit the "%" sign in your response.) Ki %

(b) Compute Ke (required rate of return on common equity based on the dividend valuation model). (Round your intermediate and final answers to 2 decimal places. Omit the "%" sign in your response.) Ke % rev: 06-20-2011

Explanation / Answer

a. Ki = Rf +beta*(km-rf)= 3%+1.5*(6%-3%)

Ki = 7.50%

b. P0= D1/(ke-g)

21= 0.6/(ke-7%)

Ke= 9.86%

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