Question

The risk-free rate of return is 5.5%, the expected rate of return on the market portfolio is 13%, and the stock of Xyrong Corporation has a beta coefficient of 2.9. Xyrong pays out 45% of its earnings in dividends, and the latest earnings announced were $8.00 per share. Dividends were just paid and are expected to be paid annually. You expect that Xyrong will earn an ROE of 15% per year on all reinvested earnings forever.

Answer 1

Risk-free rate (Rf) = 5.5%

Market return (Rm) = 13%

Beta (β) = 2.9

Earnings per share (EPS) = $8

Current dividend paid (Do) = 45% x $8 = $3.6%

Retention rate (b) = 55% = 0.55

ROE (r) = 0.15

Growth rate (g) = b x r

g = 0.55 x 0.15 = 0.0825 = 8.25%

Ke = Rf + β(Rm – Rf)

Ke = 5.5 + 2.9(13 - 5.5)

Ke = 27.25%

Step-by-step explanation:

In this question, there is need to calculate cost of equity based on capital asset pricing model. Then we will calculate the growth rate using Gordon's growth model. Finally, we will calculate the current market price of equity.