Rossdale Co. stock currently sells for $68.91 per share and has a beta of .88. The market risk premium is 7.10 percent and the risk-free rate is 2.91 percent annually. The company just paid a dividend of $3.57 per share, which it has pledged to increase at an annual rate of 3.25 percent indefinitely. What is your best estimate of the company's cost of equity?

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TomShelby TomShelby · Answer 1 · 2019-08-27T16:30:29+02:00

Answer:

Cost of Equity 8.794%

Explanation:

We can solve for the cost of equity using the CAPM

[tex]Ke= r_f + \beta (r_m-r_f)[/tex]

risk free 0.0291

premium market = market rate - risk free 0.071

beta(non diversifiable risk) 0.88

[tex]Ke= 0.0291 + 0.88 (0.071)[/tex]

Ke 0.09158 = 9.158%

Or using the gordon dividend grow model

[tex]\frac{divends_1}{return-growth} = Intrinsic \: Value[/tex]

D= 3.57

return = ?

growth 0.0325

stock = 68.91

[tex]\frac{3.57}{return-0.0325} = 68.91[/tex]

we solve for return:

[tex]\frac{3.57}{68.91} + 0.0325 = return[/tex]

return = 0,08430670 = 8.43%

Now we have two diferent rates, so we can do an average to get the best estimate cost of equity

(9.158 + 8.43)/2 = 8.794%