ADK Industries common shares sell for $60 per share. ADK expects to set their next annual dividend at $3.75 per share. If ADK expects future dividends to grow at 9% per year, indefinitely, the current risk-free rate is 4%, the expected rate on the market is 11%, and the stock has a beta of 1.5, what should be the best estimate of the firm's cost of equity?
A) 15.25%
B) 14.50%
C) 14.88%
D) 15.03%

Question

Quizplus · Accepted Answer

First, let's calculate the expected dividend yield:
Expected Dividend Yield = Dividend / Stock Price 
Expected Dividend Yield = $3.75 / $60 = 0.0625 or 6.25%

Next, let's calculate the expected capital gain yield:
Expected Capital Gain Yield = Expected Growth Rate * Beta 
Expected Capital Gain Yield = (11% - 4%) * 1.5 = 10.5%

Finally, we can calculate the cost of equity using the CAPM equation:
Cost of Equity = Risk-Free Rate + Expected Return on Market * Beta 
Cost of Equity = 4% + (11% - 4%) * 1.5 = 14.5%

Therefore, the best estimate of the firm's cost of equity is 14.88%.

ADK Industries Common Shares Sell for $60 Per Share