Question

Suppose stock of Company ABC has a beta of 1.2. The risk premium is 8%, and the risk-free rate is 6%. ABC’s last dividend was $2 per share, and the dividend is expected to grow at 8% indefinitely. The stock sells for $30. What is ABC’s cost of equity capital?

Answer 1

		Using CAPM   equation;
		Rs=Rf+Beta*(Rm-Rf)
		Rs=Expected return of stock
		Rf=Risk free rate=6%
		Rm =Market expected return
		(Rm-Rf)=Risk Premium=8%
		Beta=1.2
		Rs=6+1.2*8=	15.60%
	D0	Last dividend paid	$2
	g	Dividend growth Rate	0.08
	D1=D0*(1+g)	Next year dividend	$2.16
		Required Return onEquity=R
	P0=D1/(R-g)	P0=Market Price=$30
		30=2.16/(R-0.08)
		R=(2.16/30)+0.08=	15.20%	0.072
		CAPM:CapitalAsset Pricing Model
		DDM:Dividend Discount Model
		As Per CAPM	15.60%
		As per DDM	15.20%
		We can take the average:
		Cost of Equity	15.4%