Question

Pierce industries stock has a beta of 1.34. the company just paid a dividend of $.84, and the dividends are expected to grow at 5.4 percent. the expected return on the market is 11.9 percent, and treasury bills are yielding 5.4 percent. the most recent stock price is $83.25.
a. calculate the cost of equity using the dividend growth model method. (do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places,
e.g., 32.16.) cost of equity %
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.) cost of equity %

Answer 1

Cost of equity using DDM will be calculated as -

Under DDM,

cost of equity = Expected dividend / Current price + Growth rate

cost of equity = ($ 0.84 ( 1 + 5.4%) / % 83.25) + $ 5.4 %

cost of equity = 6.46%

Under SML, cost of equity will be calculated as -

Cost of equity = Risk free return + Beta * ( Market return - Risk free return)

Cost of equity = 5.4 % + 1.34 * ( 11.9 % - 5.4 %)

Cost of equity = 14.11 %