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 percent per year, indefinitely, the current risk-free rate is 4 percent, the expected rate on the market is 11 percent, 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 percent
B)15.03 percent
C)14.50 percent
D)14.88 percent
E)15.03 percent Step 1: Find the cost of equity using constant-growth formula: 3.75/60 + 0.09 = 15.25 percent.Step 2: Find the cost of equity using CAPM: 4 + 1.5(11 - 4) = 14.5 percent.

Question

Quizplus · Accepted Answer

The best estimate of ADK Industries' cost of equity is the average of the two methods, which is (15.25% + 14.5%) / 2 = 14.88%, as it takes into account both the constant-growth model and the capital asset pricing model. Therefore, the best choice is D.

ADK Industries Common Shares Sell for $60 Per Share