Berta Industries stock has a beta of 1.25. The company just paid a dividend of $

Question

Berta Industries stock has a beta of 1.25. The company just paid a dividend of $0.40, and the dividends are expected to grow at 5 percent. The expected return on the market is 12 percent, and Treasury bills are yielding 5.3 percent. The most recent stock price for Berta is $70.

Calculate the cost of equity using the DCF 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))

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

Explanation / Answer

Answer:

(a) Calculation of Cost of Equity using DCF Method

Cost of Equity = Current Year Dividend / Current Stock Price + growth or D1/ P0+ g

Current Year Dividend (D1) = D0(1+g) = $0.40 (1+0.05) = $0.42

Growth Rate (g) = given = 5%

Current Stock Price (P0) = $70

Cost of Equity = $0.42 / $70 + 0.05 = 0.006 + 0.05 = 0.056 or 5.60%

(b) Calculation of Cost of Equity using the SML (Security Market Line) Method

Cost of Equity = Risk Free Return + Stock Beta (Market Return – Risk Free Return) or RF+ Beta (RM- RF)

Beta of Stock = 1.25

Expected Return on Market (RM) = 12%

Yield of Treasury Bill (Risk Free Return) (RF) = 5.30%

Cost of Equity = 5.30% + 1.25 (12% - 5.30%) = $5.30% + 8.375% = 13.675%

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