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Donut delites has a beta of 1.06, a dividend growth rate of 1.2 percent, a stock price of $12a share, and an expected annual dividend of $.68 per share next year. the market rate of return is 11.4 percent and the risk-free rate is 3.8 percent. what is the firm's cost of equity?

Respuesta :

talkingturkey
Given:
Beta = 1.06
dividend growth rate = 1.2%
stock price = $12 a share
expected annual dividend = $0.68 per share
market rate of return = 11.4%
risk-free rate = 3.8%

There are 2 formulas for Cost of Equity:
1) Dividend Growth approach formula:
2) Capital Asset Pricing Model

1) Dividend Growth Approach

Cost of Equity =  (Next Year's dividends per share / Current market value of stock) + Growth rate of dividends

CoE = ($0.68 / $12) + 1.2% = 5.66% + 1.2% = 6.866%

2) CAPM formula:

Cost of Equity = Risk free rate of return + Premium expected for risk

OR

Cost of equity = Risk free rate of return + Beta × (market rate of return – risk free rate of return)

CoE = 3.8% + 1.06 * (11.4% - 3.8%)
CoE = 3.8% + 1.06 * (7.6%)
CoE = 3.8% + 8.056%
CoE = 11.856%


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