Laverne Industries stock has a beta of 1.42. The company just paid a dividend of
ID: 2713683 • Letter: L
Question
Laverne Industries stock has a beta of 1.42. The company just paid a dividend of $.92, and the dividends are expected to grow at 5.2 percent. The expected return of the market is 11.7 percent, and Treasury bills are yielding 5.2 percent. The most recent stock price is $85.25. Required: (a) Calculate the cost of equity using the dividend growth model method. (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).) Cost of equity % (b) Calculate the cost of equity using the SML method. (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).) Cost of equity %
Explanation / Answer
a)
Cost of Equity = (Next Year's Annual Dividend / Current Stock Price) + Dividend Growth Rate
= {($.92 *1.052 / 85.25) * 100} + 5.2
= (0.96784/ 85.25) + 5.2
= 6.34%
b)
ra = rf + Ba (rm-rf)
where:
rf = the rate of return on risk-free securities (typically Treasuries)= 5.2%
Ba = the beta of the investment in question = 1.42
rm = the market's overall expected rate of return= 11.7%
ra = 5.2 + 1.42 (11.7 - 5.2)
= 14.43 %
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