Stock in Daenerys Industries has a beta of 1.3. The market risk premium is 6 per

Question

Stock in Daenerys Industries has a beta of 1.3. The market risk premium is 6 percent, and T-bills are currently yielding 5 percent. The company’s most recent dividend was $2.00 per share, and dividends are expected to grow at an annual rate of 8 percent indefinitely.

If the stock sells for $36 per share, what is your best estimate of the company’s cost of equity? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Stock in Daenerys Industries has a beta of 1.3. The market risk premium is 6 percent, and T-bills are currently yielding 5 percent. The company’s most recent dividend was $2.00 per share, and dividends are expected to grow at an annual rate of 8 percent indefinitely.

Explanation / Answer

Solution-

Using the CAPM, we find:

RE = .05 + 1.3(.06)

RE = 0.128 or 12.80%

Using the dividend growth model, the cost of equity is........

RE = [$2(1.08)/$36] + .08

RE = .14 or 14.00%

Now, we will use the average of the two....

RE = (.128 + .14)/2

RE= .1340 or 13.40%

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