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 is $72.

a. Calculate the cost of equity using the dividend growth model method. Note: 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. Note: Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.

Answer 1

The cost of equity for Ginger Industries can be calculated using the dividend growth model and the Security Market Line (SML) method. Using the dividend growth model, the cost of equity is approximately 5.18%. Using the SML method, the cost of equity is approximately 11.93%.

Step-by-step explanation:

a. Cost of Equity using Dividend Growth Model Method:

The cost of equity can be calculated using the dividend growth model method. The formula for the cost of equity is: Cost of Equity = (Dividend / Stock Price) + Growth Rate

Given:

• Dividend = $0.85
• Growth Rate = 4%
• Stock Price = $72

Substituting these values into the formula:

Cost of Equity = (0.85 / 72) + 0.04 = 0.0118056 + 0.04 = 0.0518056

Rounded to 2 decimal places, the cost of equity using the dividend growth model method is approximately 5.18%.

b. Cost of Equity using SML Method:

The cost of equity can also be calculated using the Security Market Line (SML) method. The formula for the cost of equity using SML is: Cost of Equity = Risk-Free Rate + (Beta × Market Risk Premium)

Given:

• Risk-Free Rate = 3.4%
• Beta = 1.08
• Market Risk Premium = 11.3% - 3.4% = 7.9%

Substituting these values into the formula:

Cost of Equity = 3.4% + (1.08 × 7.9%) = 3.4% + 8.532% = 11.932%

Rounded to 2 decimal places, the cost of equity using the SML method is approximately 11.93%.