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17 June, 20:30

Excelor stock is expected to pay $3.00 per share as its next annual dividend. The firm has a policy of increasing the dividend by 11.0 percent annually. The stock has a market price of $13.65 and a beta of 2.8. The market risk premium is 8.56 percent and the risk-free rate is 4.90 percent. What is the cost of equity?

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  1. 17 June, 21:31
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    30.92%

    Explanation:

    You find the answer by calculating the cost of equity using two methods; Dividend discount model and CAPM

    Dividend discount model;

    cost of equity; r = (D1/P0) + g

    whereby, D1 = next year's dividend = 3.00

    P0 = current price = 13.65

    g = dividend growth rate = 11% or 0.11 as a decimal

    r = (3/13.65) + 0.11

    r = 0.2198 + 0.11

    r = 0.3298 or 32.98%

    Using CAPM;

    r = risk free + beta (Market risk premium)

    r = 0.049 + (2.8 * 0.0856)

    r = 0.049 + 0.2397

    r = 0.2887 or 28.87%

    Next, find the average of the two cost of equities;

    = (32.98% + 28.87%) / 2

    = 30.92%
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