Question

Mackenzie Company has a price of $32 and will issue a dividend of $2.00 next year. It has a beta of 1.5​, the​ risk-free rate is 5.3%​, and the market risk premium is estimated to be 5.1%.a. Estimate the equity cost of capital for Mackenzie.b. Under the​ CGDM, at what rate do you need to expect​ Mackenzie's dividends to grow to get the same equity cost of capital as in part ​(a​)?

Answer 1

Answer:

(a) 12.95%

(b) 6.70%

Explanation:

(a)

Risk free rate = 5.30%

Risk Premium = 5.10%

Beta = 1.50

Cost of Equity is calculated below using CAPM formula:

Expected rate of return:

= Risk free rate + Risk Premium × Beta

= 5.30% + 5.10% × 1.50

= 5.30% + 7.65%

= 12.95%

Hence, Cost of equity for company stock is 12.95%.

(b) Value of stock = Expected dividend ÷ (cost of equity - Growth rate)

$32 = $2 ÷ (12.95% - Growth rate)

(12.95% - Growth rate) = $2 ÷ $32

Growth rate = 12.95% - 6.25%

                    = 6.70%

Hence, the growth rate in dividend is 6.70%.