ADK Industries common shares sell for $40 per share. ADK expects to set their next annual dividend at $1.75 per share. If ADK expects future dividends to grow at 7 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 1.2, what should be the best estimate of the firm's cost of equity?
A)11.89 percent
B)11.38 percent
C)12.40 percent
D)12.71 percent

Question

Quizplus · Accepted Answer

The correct answer is A because the cost of equity is 11.89 percent, which is calculated using the Capital Asset Pricing Model (CAPM). The CAPM formula is:Cost of equity = Risk-free rate + Beta * (Expected market return - Risk-free rate)Plugging in the given values, we get:Cost of equity = 4% + 1.2 * (11% - 4%)Cost of equity = 4% + 1.2 * 7%Cost of equity = 4% + 8.4%Cost of equity = 11.89%

ADK Industries Common Shares Sell for $40 Per Share