Question

Floyd Industries stock has a beta of 1.20. The company just paid a dividend of $.50 and the dividends are expected to grow at 6 percent per year. The expected return on the market is 11 percent, and Treasury bills are yielding 5.9 percent. The most recent stock price for the company is $76. a. Calculate the cost of equity using the dividend growth method. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) b. Calculate the cost of equity using the SML method. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

Answer: a. Ke = Do(1+g)/po + g

Ke = 0.5(1+0.06)/76 + 0.06

Ke = 6.70%.

b. Ke = Rf + B(Rm-Rf).

Ke = 5.9 + 1.20(11-5.9)

ke = 12.02%. Explanation: a. Cost of equity is a function of current dividend paid multiplied by 1+growth rate divided by current market price plus growth rate. This method is referred to as dividend growth model. b. Using SML ke equals risk free rate plus the product of beta and risk premium. Risk premium is the difference between market return and risk free rate.