Question

Stock in Daenerys Industries has a beta of 1.2. The market risk premium is 5 percent, and T-bills are currently yielding 4.2 percent. The company's most recent dividend was $1.40 per share, and dividends are expected to grow at an annual rate of 5 percent indefinitely. If the stock sells for $30 per share, what is your best estimate of the company's cost of equity?

Answer 1

The best estimate of the company's cost of equity is 10.05%.

Explanation:

Using growth rate model formula, the cost of equity can be calculated as follows:

Cost of equity as per growth rate model = (D1 / P) + g ................ (1)

D1 = Most recent dividend * (1 + g) = $1.40 * (1 + 0.05) = $1.47

P = Current price per share = $30

g = Growth rate of dividend = 5%, or 0.05

Substituting the values into equation (1), we have:

Cost of equity as per growth rate model = ($1.47 / $30 ) + 0.05

Cost of equity as per growth rate model = 0.099. or 9.90%

Using Capital Asset Pricing Model (CAPM) formula, the cost of equity can be calculated as follows:

Cost of equity as per CAPM = Risk free rate + (Beta * Market risk premium) = 4.2 + (1.2 * 5) = 10.20%

Therefore, we have:

Best estimate of Cost of equity = (Cost of equity as per growth rate model + Cost of equity as per CAPM) / 2 = (9.90% + 10.20%) / 2 = 10.05%

Therefore, the best estimate of the company's cost of equity is 10.05%.