Question

The expected return on the market is 11 percent. The common stock of Trompeta Inc. has a beta of 1.20 and the company just paid an annual dividend of $.50. Trompeta Inc.'s dividends are expected to grow indefinitely at 6 percent annually, and the most recent stock price for the company is $82. Calculate the cost of equity. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

Information provided:

Expected return on the market= 11%

Beta= 1.20

Annual dividend= $0.50

Dividend growth rate= 6%

Current stock price= $82

The cost of equity is calculated using the dividend discount model. It is calculated using the below formula:

Ke=D1/Po+g

Where:

D1= Next year’s dividend

Po=Current stock price

g=Firm’s growth rate

Ke= Required rate of return on equity

Ke= $0.50*(1 + 0.06)/ $82 + 0.06

     = $0.53/ $82 + 0.06

     = 0.0065 +0.06

     = 0.0665*100

     = 6.65%.

Therefore, the cost of equity is 6.65%.

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