13. Hybrid Motors has paid increasing dividends of $.42,$.50, $.55, $.65, and $.
ID: 2662500 • Letter: 1
Question
13. Hybrid Motors has paid increasing dividends of $.42,$.50, $.55, $.65, and $.80 a share over the past five years,respectively. The firm estimates that future increases in itsdividends will be comparable to the arithmetic average growth rateover these past five years. The stock is currently selling for$41.50 a share. The risk-free rate is 3.5 percent and the marketrisk premium is 8.6 percent. What is the cost of equity for HybridMotors if the firm's beta is 1.42?
A. 12.49 percent
B. 15.45 percent
C. 17.78 percent
D. 18.67 percent
E. 19.24 percent
Explanation / Answer
According to the given problem,
Risk-free rate (Kf ) is 3.5%
Market- risk premium(Km - Kf ) is 8.6%
Beta ( ) is 1.42
The formula for calculating Cost of Equity using SML modelis
Ke = Krf + (Km – Kf )
By substituting the above values in the given formula, weget
Ke = 0.035 + 1.42 ( 0.086) = 0.035 +0.122 = 0.157 or 15.7% which is approximately equal to optionB.
Conclusion: Hence, the cost of equity is 15.7%
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