Laverne Industries stock has a beta of 1.41. The company just paid a dividend of
ID: 2767360 • Letter: L
Question
Laverne Industries stock has a beta of 1.41. The company just paid a dividend of $.91, and the dividends are expected to grow at 5.1 percent. The expected return of the market is 11.6 percent, and Treasury bills are yielding 5.1 percent. The most recent stock price is $85.00.
Calculate the cost of equity using the dividend growth model method. (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)
Calculate the cost of equity using the SML method. (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)
Laverne Industries stock has a beta of 1.41. The company just paid a dividend of $.91, and the dividends are expected to grow at 5.1 percent. The expected return of the market is 11.6 percent, and Treasury bills are yielding 5.1 percent. The most recent stock price is $85.00.
Explanation / Answer
Solution:
(a)
Dividend Paid (Do) = $0.91
Growth Rate = 5.1% or 0.051
Current Stock Price = $85
Cost of Equity as per dividend growth Model
Cost of Equity = Next Year Expected Dividend (D1) / Current Stock Price + Growth Rate
Next Year Expected Dividend (D1) = Do x (1 + Growth Rate) = $0.91 x 1.051 = $0.95641
Cost of Equity = $0.95641 / $85 + 0.051 = 0.01125 + 0.051 = 0.06225 or 6.225% or 6.23%
(b)
Cost of Equity using SML Method
Security Market Line (SML) is a graphical representation of CAPM. SML describe the relationship between two variable return and beta.
Cost of Equity = Risk Free Return + Beta (Market Return – Risk Free Return)
Risk Free Return = Treasury bills yield = 5.1%
Expected Market Return = 11.6%
Beta = 1.41
Cost of Equity = 5.1% + 1.41 (11.60% - 5.1%)
= 5.1% + 9.165%
= 14.265% or 14.27%
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