Stock in Daenerys Industries has a beta of 1.2. The market risk premium is 6 per

Question

Stock in Daenerys Industries has a beta of 1.2. The market risk premium is 6 percent, and T-bills are currently yielding 5.3 percent. The company’s most recent dividend was $1.70 per share, and dividends are expected to grow at an annual rate of 5 percent indefinitely.

If the stock sells for $35 per share, what is your best estimate of the company’s cost of equity? (Hint: As you have two approaches, calculate each and take the average as your "best estimate".)

Cost of Equity? ____%

Stock in Daenerys Industries has a beta of 1.2. The market risk premium is 6 percent, and T-bills are currently yielding 5.3 percent. The company’s most recent dividend was $1.70 per share, and dividends are expected to grow at an annual rate of 5 percent indefinitely.

Explanation / Answer

Cost of equity as per SLM=Risk free rate+beta*MArket risk premium

=5.3+(1.2*6)=12.5%

Cost of equity as per dividend discount model=(Dividend for next period/Current price)+Growth rate

=(1.7*1.05)/35+0.05=10.1%

Hence cost of equity=(12.5+10.1)/2=11.3%

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