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. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

DDM method

%

b.	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.)

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%