Stock in CDB Industries has a beta of .95. The market risk premium is 7 percent,
ID: 2751124 • Letter: S
Question
Stock in CDB Industries has a beta of .95. The market risk premium is 7 percent, and T-bills are currently yielding 4.0 percent. CDB’s most recent dividend was $2.40 per share, and dividends are expected to grow at a 5 percent annual rate indefinitely.
If the stock sells for $46 per share, what is your best estimate of CDB’s cost of equity? Hint: Calculate cost of equity using both CAPM and DGM and average them.(Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)
Stock in CDB Industries has a beta of .95. The market risk premium is 7 percent, and T-bills are currently yielding 4.0 percent. CDB’s most recent dividend was $2.40 per share, and dividends are expected to grow at a 5 percent annual rate indefinitely.
Explanation / Answer
Cost of Equity = 10.57%
Beta = 0.95
Market risk premium = 7%
T-bill yield rf = 4%
Most recent dividend = $ 2.40
Growth rate of earnings and dividends = 5%
Current stock price = $ 46
Expected rate of return as per CAPM
Expected return = T-bill yield + Beta * risk premium
= 4% + 0.95 * 7% = 4% + 6.65%
= 10.65%
Required rate of return based on Dividend Growth Model
Expected dividend next year = Current dividend * (1+growth rate)
= $ 2.40 * (1+0.05) = $ 2.40 * 1.05
= $ 2.52
Current Price = Expected Dividend /(Cost of Equity - growth rate)
$ 46 = $ 2.52 /(Cost of Equity – 0.05)
Cost of Equity – 0.05 = ($2.52/$ 46)
Cost of Equity = ($2.52/$46) + 0.05 = 0.0547826 + 0.05
= 0.1047826 or 10.48% (rounded off)
Average of Expected return and Cost of equity = (10.65%+10.48%)/2 = 10.565% or 10.57%
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.