Rosie's Grill has a beta of 1.2, a stock price of $26 and an expected annual dividend of $1.30 a share, which is to be paid next month. The dividend growth rate is 4 percent. The market has a 10
Percent rate of return and a risk premium of 6 percent. What is the average expected cost of equity
For Rosie's Grill?

Question

Quizplus · Accepted Answer

The formula to calculate the cost of equity is:
Cost of equity = Risk-free rate + Beta x (Market rate of return - Risk-free rate)
= 4% + 1.2 x (10% - 4%)
= 4% + 1.2 x 6%
= 4% + 7.2%
= 10.2%
However, this is the cost of equity before considering the dividend yield. To adjust for the dividend yield, we subtract the expected dividend yield from the cost of equity:
Cost of equity = 10.2% - ($1.30 / $26) x 100 + 4%
= 10.2% - 5% + 4%
= 9.2%
Therefore, the average expected cost of equity for Rosie's Grill is 9.2%. The closest option is C) 10.10 percent.

Rosie's Grill Has a Beta of 1