Question

Rossdale Co. stock currently sells for $73.09 per share and has a beta of 1.23. The market risk premium is 7.00 percent and the risk-free rate is 2.86 percent annually. The company just paid a dividend of $4.33 per share, which it has pledged to increase at an annual rate of 3.35 percent indefinitely. What is your best estimate of the company's cost of equity

Answer 1

Step-by-step explanation:

The cost of equity can be estimated using two (2) different models:

1. The Dividend Valuation Model
2. The capital asset pricing model (CAPM)

The Dividend Valuation Model(DVM) is a technique used to value the worth of an asset. According to this model, the value of an asset is the sum of the present values of the future cash flows would that arise from the asset discounted at the required rate of return.

The model is stated below as follows

P = D(1+g)/ke-g)

The capital asset pricing model (CAPM): relates the price of a share to the market risk or systematic risk. The systematic risk is that which affects all the all the economic agents, e.g inflation, interest rate e.t.c

This model is considered superior to DVM. Hence, we will use the CAPM

Using the CAPM , the expected return on a asset is given as follows:

E(r)= Rf +β(Rm-Rf)

E(r) =? , Rf- 2.86%, Rm-Rf - 7.00 β- 1.23

E(r) = 2.86% + 1.23× 7%

= 2.86% + 8.61%

= 11.47 %

Cost of equity= 11.47 %