Stock in Country Road Industries has a beta of 0.92. The market risk premium is

Question

Stock in Country Road Industries has a beta of 0.92. The market risk premium is 8 percent, and T-bills are currently yielding 3 percent. The company's most recent dividend was $1.7 per share, and dividends are expected to grow at a 3.5 percent annual rate indefinitely. If the stock sells for $36 per share, what is your best estimate of the company's cost of equity?

Stock in Country Road Industries has a beta of 0.92. The market risk premium is 8 percent, and T-bills are currently yielding 3 percent. The company's most recent dividend was $1.7 per share, and dividends are expected to grow at a 3.5 percent annual rate indefinitely. If the stock sells for $36 per share, what is your best estimate of the company's cost of equity?

Explanation / Answer

Usimg Dividend discount model:

D0 = 1.7
growth = 3.5%
Price = 36

Price = D0*(1+g) / (ROE - g)

ROE = [ D0*(1+g) / Price] + g
ROE = 1.7*(1+3.5%) / 36 + 3.5%
          = [1.7595 / 36] + 3.5%

          = 4.89% + 3.5%
          = 8.39% (rounded to 2 decimals)

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