National Home Rentals has a beta of 1.06, a stock price of $17, and recently paid an annual dividend of $.92 a share. The dividend growth rate is 2.2 percent. The market has a rate of return of 11.2 percent and a risk premium of 7.3 percent. What is the estimated cost of equity using the average return of the CAPM and the dividend discount model?

Question

Quizplus · Accepted Answer

The cost of equity using CAPM is calculated as: Risk-free rate = Market return - Risk premium = 11.2% - 7.3% = 3.9%. CAPM = Risk-free rate + Beta * Risk premium = 3.9% + 1.06 * 7.3% = 11.628%. The cost of equity using the dividend discount model (DDM) is: DDM = (Dividend / Price) + Growth rate = ($0.92 / $17) + 2.2% = 7.61%. The average of CAPM and DDM is (11.628% + 7.61%) / 2 = 9.619%, approximately 9.68%.

National Home Rentals Has a Beta of 1