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Rossdale Co. stock currently sells for $68.69 per share and has a beta of .87. The market risk premium is 7.30 percent and the risk-free rate is 2.89 percent annually. The company just paid a dividend of $3.53 per share, which it has pledged to increase at an annual rate of 3.20 percent indefinitely. What is your best estimate of the company's cost of equity?

Respuesta :

jepessoa

Answer:

8.5%

Explanation:

we can calculate the company's cost of equity in two different ways:

Re = risk free rate + (beta x market risk premium) = 2.89% + (0.87 x 7.3%) = 9.24%

or

we can use the dividend growth model

Pā‚€ = Divā‚ / (Re - g)

Re - g = Divā‚ / Pā‚€

Re = Divā‚ / Pā‚€ + g

  • Divā‚ = $3.53 x 1.032 = $3.64296
  • Pā‚€ = $68.69
  • g = 3.2%

Re = $3.64296/$68.69 + 3.2% = 8.5%

Personally, I would consider the second calculation to be more exact since the market knows better.

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