Question

Boltzmann Energy has a beta of 1, a variance of 0.0251, a dividend growth rate of 2.4 percent, a stock price of $32 a share, and an expected annual dividend of $1.41 per share next year. The market rate of return is 10.5 percent and the risk-free rate is 3.5 percent. What is the cost of equity (in percents) for Boltzmann Energy?

Answer 1

Using Gordon Growth Model

Po = D1 / (Ke – g)

Where,

Po – Current share price = 32

D1 – Next year expected dividend = 1.41

Ke – Cost of equity = ?

G – Growth rate in dividend = 2.4%

32 = 1.41/(Ke-.024)

Ke-.024 = 1.41/32 = 0.0440625

Ke = 0.0440625 + .024

= 0.0680625

Ke = 6.81%

Using Capital Asset Pricing Model

Cost of Equity Ke = Rf + b ( Rm – Rf )

Where,

Rf – Risk free return = 3.5%

b – Beta = 1

Rm – Expected return on market portfolio = 10.5%

Cost of Equity Ke = 3.5+ 1*(10.5-3.5)

= 3.5+7

= 10.50%

Here we are getting different answers under both methods. So cost of equity for Boltzmann Energy can be calculated as average of the two above

Cost of Equity = (6.81+10.5)/2

= 17.31/2

= 8.66%