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 4.3 percent. The company’s most recent dividend was $1.50 per share, and dividends are expected to grow at an annual rate of 8 percent indefinitely.

If the stock sells for $45 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 4.3 percent. The company’s most recent dividend was $1.50 per share, and dividends are expected to grow at an annual rate of 8 percent indefinitely.

Explanation / Answer

Ke using CAPM method = Risk free rate + Beta * Market risk premium

= 4.3+1.3*6

= 12.10%

Ke using dividend growth model

P0 = D1/Ke-G

45 = 1.50(1+0.08)/Ke-0.08

45(Ke-0.08) = 1.50*1.08

45Ke-3.60 = 1.62

45Ke = 1.62+3.60

Ke = 5.22/45 i.e 11.60%

Best estimatev of Ke = 11.60% to 12.10%

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