Question

Stock in Country Road Industries has a beta of 0.87. The market risk premium is 9.5 percent, and T-bills are currently yielding 4.5 percent. The company's most recent dividend was $1.9 per share, and dividends are expected to grow at a 6 percent annual rate indefinitely. If the stock sells for $38 per share, what is your best estimate of the company's cost of equity? (Do not round your intermediate calculations.)

Answer 1

Cost of equity using CAPM = Risk free rate + beta(market risk premium)

Cost of equity using CAPM = 4.5% + 0.87(9.5%)

Cost of equity using CAPM = 4.5% + 8.265%

Cost of equity using CAPM = 12.765%

Next year dividend = 1.9 (1 + 6%) = 2.014

Cost of equity using dividend discount model = (D1 / price) + growth rate

Cost of equity using dividend discount model = (2.014 / 38) + 0.06

Cost of equity using dividend discount model = 0.113 or 11.3%

Cost of equity = (12.765% + 11.3%) / 2

Cost of equity = 12.03%