Question

Ginger Industries stock has a beta of 1.08. The company just paid a dividend of $.85, and the dividends are expected to grow at 4 percent. The expected return on the market is 11.3 percent, and Treasury bills are yielding 3.4 percent. The most recent stock price for the company is $72.

a. Calculate the cost of equity using the DCF 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 is complete but not entirely correct.
a. DCF method
b. SML method

Answer 1

The cost of equity for Ginger Industries using the DCF method is 5.18%, while using the SML method it is 11.93%. These calculations are based on given financial figures including dividend, market price, beta, expected market return, and T-bills yield.

Step-by-step explanation:

The student asked about calculating the cost of equity for Ginger Industries using the Dividend Discount Model (DCF) and the Security Market Line (SML) method. To calculate the cost of equity using the DCF method, we use the formula:

Cost of Equity = (Dividends Per Share / Current Market Price Per Share) + Growth Rate of Dividends

Using the given information:
($0.85 / $72) + 0.04 = 0.0118 + 0.04 = 0.0518 or 5.18%.

For the SML method, we use the Capital Asset Pricing Model (CAPM):

Cost of Equity = Risk-Free Rate + [Beta * (Market Return - Risk-Free Rate)]

Here, we plug in the values provided:
3.4% + [1.08 * (11.3% - 3.4%)] = 3.4% + [1.08 * 7.9%] = 3.4% + 8.532% = 11.932% or 11.93%

Hence, the cost of equity using the DCF method is 5.18%, and using the SML method is 11.93%.