National Home Rentals has a beta of 1.24, a stock price of $22, and recently pai

Question

National Home Rentals has a beta of 1.24, a stock price of $22, and recently paid an annual dividend of $0.94 a share. The dividend growth rate is 4.5 percent. The market has a 10.6 percent rate of return and a risk premium of 7.5 percent. What is the firm's cost of equity? A 7.05 percent B 8.67 percent C 9.13 percent D 10.30 percent E 10.68 percent

Explanation / Answer

Market risk premium = Market return - Risk free rate =>7.5 = 10.6 - Risk free rate => Rf = 3.1% (1) by CAPM Ke = Rf + Beta*Market risk premium => Ke = 3.1% + 1.24(7.5) = 12.4% ( 2) By DDM Po = Do*(1+ growth rate)/(Ke-g) => 22=0.94(1+0.045)/(Cost of equity-0.045) =>Ke = 8.965% Cost of equity = average value from DDM and CAPM =>Cost of equity = 1/2*(8.965+12.4) = 10.68% ans :E

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