The return on the market is 11%.A firm's beta is 1.4,and the risk-free rate is 6%.The stock is currently selling for $18 and the next dividend is expected to be $1.75.The firm's growth rate is 5%.The pre-tax cost of debt is 10% and the equity risk premium is 5%.Estimate the cost of equity by taking an average of the three methods to determine the cost of equity.

Question

Quizplus · Accepted Answer

Step 1 - Use CAPM to estimate the cost of equity. k_e = k_F + β(k_M - k_F) k_e= .06 + 1.4(.11 - .06) k_e = 13% Step 2 - Use the constant growth model to estimate the cost of equity. k_e = 11ea7fdb_fc6c_b738_a768_634b8c75a450_TB2902_11 + g k_e = 11ea7fdb_fc6c_b739_a768_4d910abb8618_TB2902_11 + .05 k_e = 14.72% Step 3 - Compute the bond yield plus premium. k_e = k_d + Θ k_e = 0.10 + 0.05 = 0.15 or 15% Step 4 - Average the three methods together. 11ea7fdb_fc6c_de4a_a768_b5196feaf092_TB2902_11 = 0.142 or 14.2%

The Return on the Market Is 11