Question

Floyd Industries stock has a beta of 1.20. The company just paid a dividend of $.50, and the dividends are expected to grow at 6 percent per year. The expected return on the market is 11 percent, and Treasury bills are yielding 5.2 percent. The most recent stock price for the company is $69. |

a. |
Calculate the cost of equity using the DDM method. |

DDM method | % |

b. |
Calculate the cost of equity using the SML method. |

SML method | % |

Answer #1

1) Calculation of cost of equity using DDM method: | ||||||

D0= $0.50 | ||||||

D1= D0*(1+growth)= 0.50*(1+0.06)= $0.53 | ||||||

Growth= 6% | ||||||

current price= $69 | ||||||

Cost of equity= (D1/current price)+growth | ||||||

Cost of equity=(0.53/69)+0.06= 0.00768+0.06 | ||||||

Cost of equity= 6.77% | ||||||

2) Calculation of cost of equity using SML method: | ||||||

Risk free rate= 5.2% | ||||||

Market return= 11% | ||||||

Beta= 1.2 | ||||||

Required return= Risk free rate+beta*(market return- risk free rate) | ||||||

Required return= 5.2+1.2*(11-5.2)= 12.16% | ||||||

Required return= 12.16% |

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