Floyd Industries stock has a beta of 1.20. The company just paid a dividend of $

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 Floyd is $69.

Calculate the cost of equity using the DDM method. (Round your answer to 2 decimal places. (e.g., 32.16))

Calculate the cost of equity using the SML method. (Round your answer to 2 decimal places. (e.g., 32.16))

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 Floyd is $69.

Explanation / Answer

Using the dividend discount model, the cost of equity is:

RE = (D1/P) + g

D1 = dividend per share to be received next year = $0.50 x( 1+ 6%)

P = the price per share of a stock

g = the constant annual growth rate in dividend per share

RE = (D1/P )+ g

DCF method

RE = RF + (RM – RF)

(RM – RF) = the different between the expected return on the market portfolio and the riskless rate = 11% - 5.2%

= Beta

RF = the risk free rate

RE = RF + (RM – RF)

RE = 5.2% + 1.20 x (5.8%)

a.

Using the dividend discount model, the cost of equity is:

RE = (D1/P) + g

D1 = dividend per share to be received next year = $0.50 x( 1+ 6%)

0.53

P = the price per share of a stock

69

g = the constant annual growth rate in dividend per share

6%

RE = (D1/P )+ g

RE = ($0.53/$69) + 6% = 6.8%

DCF method

6.8% b. Using the CAPM, the cost of equity is:

RE = RF + (RM – RF)

(RM – RF) = the different between the expected return on the market portfolio and the riskless rate = 11% - 5.2%

5.800%

= Beta

1.2

RF = the risk free rate

5.20%

RE = RF + (RM – RF)

RE = 5.2% + 1.20 x (5.8%)

12.16% SML method 12.16%

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