1. Your portfolio consists of two stocks: 90 shares of Stock A that sell for $36
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Question
1. Your portfolio consists of two stocks: 90 shares of Stock A that sell for $36 per share and 110 shares of Stock B that sell for $20 per share.
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2. The expected return on the market is 13 percent, and Treasury bills are yielding 6.3 percent. The common stock of Trompeta Inc. has a beta of 1.30 and the dividends are expected to grow indefinitely at 4 percent annually. The most recent stock price for the company is $80.
Calculate the cost of equity.
3. Davidson Consulting believes that they can help your company reduce production costs in exchange for a one-time fee. You estimate that, if you hire the consulting firm, the cost savings will be $1.74 million after-taxes at the end of the first year, and these cost savings will grow at a rate of 1.00 percent per year indefinitely. Your company estimates the cost of capital on this project as 10.31 percent.
Maximum cost?
1. Your portfolio consists of two stocks: 90 shares of Stock A that sell for $36 per share and 110 shares of Stock B that sell for $20 per share.
Explanation / Answer
Answer 1.
Stock A:
Number of shares = 90
Price per share = $36
Value of Stock A = Number of shares * Price per share
Value of Stock A = 90 * $36
Value of Stock A = $3,240
Stock B:
Number of shares = 110
Price per share = $20
Value of Stock B = Number of shares * Price per share
Value of Stock B = 110 * $20
Value of Stock B = $2,200
Value of Portfolio = Value of Stock A + Value of Stock B
Value of Portfolio = $3,240 + $2,200
Value of Portfolio = $5,440
Weight of Stock A = Value of Stock A / Value of Portfolio
Weight of Stock A = $3,240 / $5,440
Weight of Stock A = 0.5956
Weight of Stock B = Value of Stock B / Value of Portfolio
Weight of Stock B = $2,200 / $5,440
Weight of Stock B = 0.4044
Answer 2.
Cost of Equity = Risk-free Rate + Beta * (Market Return - Risk-free Rate)
Cost of Equity = 6.3% + 1.30 * (13% - 6.3%)
Cost of Equity = 6.3% + 1.30 * 6.7%
Cost of Equity = 15.01%
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