Stock in Daenerys Industries has a beta of 1.2. The market risk premium is 8 per

Question

Stock in Daenerys Industries has a beta of 1.2. The market risk premium is 8 percent, and T-bills are currently yielding 5.1 percent. The company’s most recent dividend was $1.50 per share, and dividends are expected to grow at an annual rate of 8 percent indefinitely.

If the stock sells for $40 per share, what is your best estimate of the company’s cost of equity? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Stock in Daenerys Industries has a beta of 1.2. The market risk premium is 8 percent, and T-bills are currently yielding 5.1 percent. The company’s most recent dividend was $1.50 per share, and dividends are expected to grow at an annual rate of 8 percent indefinitely.

Explanation / Answer

Answer:Cost of equity =13.38%

Working notes for the above answer is as under

CAPM-

  .051 + 1.2(.08)

= 0.147

or 14.7%

Dividend growth model-   RE

= (1.50(1.08)/40) + .08

= 0.1205

or 12.05%

We will use the average

(0.147 + 0.1205)/2

= 0.1338

or 13.38%

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