Question

Mackenzie Company has a price of $36 and will issue a dividend of$200 next year. It has a beta of 1.2, the risk-free rate is 5.5%, and the market risk premium is estimated to be 5.0% a. Estimate the equity cost of capital for Mackenzie. b. Under the CGDM, at what rate do you need to expect Mackenzie's dividends to grow to get the same equity cost of capital as in part (a)?

a. Estimate the equity cost of capital for Mackenzie. The equity cost of capital for Mackenzie-U96. (Round to two decimal places.)
b. Under the CGDM, at what rate do you need to expect Mackenzie's dividends to grow to get the same equity cost of capital as in part (a)? The expected growth rate for dividends is%.

Answer 1

The equity cost of capital for Mackenzie is 11.5%. Under the CGDM, the expected growth rate for Mackenzie's dividends to match the equity cost of capital is 48.26%.

Step-by-step explanation:

To estimate the equity cost of capital for Mackenzie, we use the Capital Asset Pricing Model (CAPM), which is given by the formula Equity Cost of Capital = Risk-Free Rate + Beta * (Market Risk Premium). Plugging in the given values:

• Risk-Free Rate = 5.5%
• Beta = 1.2
• Market Risk Premium = 5.0%

Equity Cost of Capital = 5.5% + 1.2 * (5.0%) = 5.5% + 6.0% = 11.5%

Now, to determine the growth rate under the Constant Growth Dividend Model (CGDM), the formula D1 / (Equity Cost of Capital - Growth Rate) is used, where D1 is the next year's dividend which is $200 and the price is $36. Therefore:

$200 / ($36 * 11.5%) = Growth Rate

Growth Rate = $200 / $4.14 - 1 = 0.4826 or 48.26%