Floyd Industries stock has a beta of 1.30. The company just paid a dividend of $

Question

Floyd Industries stock has a beta of 1.30. The company just paid a dividend of $.30, and the dividends are expected to grow at 4 percent per year. The expected return on the market is 13 percent, and Treasury bills are yielding 6.3 percent. The most recent stock price for the company is $80.

Calculate the cost of equity using the DDM method. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Calculate the cost of equity using the SML method. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Floyd Industries stock has a beta of 1.30. The company just paid a dividend of $.30, and the dividends are expected to grow at 4 percent per year. The expected return on the market is 13 percent, and Treasury bills are yielding 6.3 percent. The most recent stock price for the company is $80.

Explanation / Answer

a.

Cost of equity Using DDM method

Cost of equity = [Current Dividend × (1 + Growth rate) / Current Stock Price] + Growth rate

= [$0.30 × (1 + 4%) / $80] + 4%

= ($0.312 / $80) + 4%

= 0.39% + 4%

= 4.39%

Cost of equity using DDM model is 4.39%.

b.

Cost of equity using SML method

Risk free rate = 6.3%

Beta risk = 1.30

Market return = 13%

Cost of equity is calculated below using CAPM formula:

Cost of equity = Risk free rate + (Market Return - Risk free rate) × Beta

                        = 6.3% + (13% - 6.30%) × 1.30

                        = 6.3% + (6.70% × 1.30)

                       = 6.3% + 8.71%

                        = 15.01%

Cost of equity is 15.01%.  

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