Stock in CDB industries has a beta of .90 the market risk premium is 7 percent a

Question

Stock in CDB industries has a beta of .90 the market risk premium is 7 percent and the t-bills are currently yielding 3.5 percent. CDB's most recent dividend was $1.80 per share and dividends are expected to grow at a 5 percent annual rate indefinitely. If the store sells for $47 per share, what is your best estimate of CDB's cost of equity? Stock in CDB industries has a beta of .90 the market risk premium is 7 percent and the t-bills are currently yielding 3.5 percent. CDB's most recent dividend was $1.80 per share and dividends are expected to grow at a 5 percent annual rate indefinitely. If the store sells for $47 per share, what is your best estimate of CDB's cost of equity?

Explanation / Answer

Using Capital Assets Pricing Model

E(r) = Rf + B ( Rm - Rf ) = 0.035 + (0.90)(0.07) = 9.8%

Using Gordon Growth Model

P0 = D0 (1 + g) / ( r - g )

$47 = $1.80 ( 1 + 0.05) / ( r - 0.05)

$1.89 / 47 = r - 0.05

r = 0.04021 + 0.05

r = 9.02%

Market value rate below the CAPM rate but here we can chose CAPM rate because it shows historic view of volatility.

At CAPM rate, the stock valued at

P0 = $1.89 / (0.098 - 0.05) = $39.38

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