Question

Commercial Construction Builders has a beta of 1.34, a dividend growth rate of 2.1 percent for the foreseeable future, a stock price of $15 per share, and an expected annual dividend of $0.45 per share next year. The market rate of return is 12.8 percent and the risk-free rate is 4.2 percent. What is the firm's average cost of equity?​

Answer 1

Answer:

10.412%

Explanation:

The computation of the average cost of equity of the firm is shown below;

The Cost of equity as per CAPM is

= risk free rate + beta × (market rate - risk free rate)

= 4.2 + 1.34 × (12.8 - 4.2)

= 15.724%

Now the Cost of equity as per growth model is

= (D1 ÷ Current price) +Growth rate

= [0.45 ÷ 15] + 0.021

= 5.1%

Now the Average Cost of equity is

= (15.724 + 5.1) ÷ 2 2

= 10.412%

Answer 2

The firm's average cost of equity is 10.412%.

The first thing to do will be to calculate the cost of equity as per CAPM which will be:

= risk free rate + beta × (market rate - risk free rate)

= 4.2 + 1.34 × (12.8 - 4.2)

= 15.724%

Then, we'll calculate the cost of equity as per growth model which will be:

= (D1 / Current price) + Growth rate

= [0.45 / 15] + 0.021

= 5.1%

Therefore, the average cost of equity will be:

= (15.724 + 5.1) / 2

= 10.412%

Therefore, the firm's average cost of equity is 10.412%.

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