Stock in CDB Industries has a beta of .95. The market risk premium is 7 percent,

Question

Stock in CDB Industries has a beta of .95. The market risk premium is 7 percent, and T-bills are currently yielding 4.0 percent. CDB’s most recent dividend was $2.40 per share, and dividends are expected to grow at a 5 percent annual rate indefinitely. The stock sells for $46 per share.

Using the CAPM, what is your estimate of CDB’s cost of equity? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

Using the dividend discount model, what is your estimate of CDB’s cost of equity? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

What is your best estimate of CDB’s cost of equity? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

Stock in CDB Industries has a beta of .95. The market risk premium is 7 percent, and T-bills are currently yielding 4.0 percent. CDB’s most recent dividend was $2.40 per share, and dividends are expected to grow at a 5 percent annual rate indefinitely. The stock sells for $46 per share.

Explanation / Answer

solution :

CAPM Method

cost of equity = risk free rate + beta(market risk premium)

10.65%

4+.95(7)

dividend discount model

10.48%

P0 = D1/(Ke-g)

46 = 2.4x1.05/(ke-.05)

best estimate of CDB’s cost of equity

10.65%

CAPM Method

cost of equity = risk free rate + beta(market risk premium)

10.65%

4+.95(7)

dividend discount model

10.48%

P0 = D1/(Ke-g)

46 = 2.4x1.05/(ke-.05)

best estimate of CDB’s cost of equity

10.65%

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