Groves, Inc. pays an annual dividend of $1.22, which is expected to grow at a rate of 5 percent each year. The firm is in a fairly risky business and has a beta of 1.45. The return on the market is 13.5 percent, and the risk-free rate is 9.3 percent. What is the cost of Groves' equity from retained earnings?

Question

Quizplus · Accepted Answer

Using the CAPM model:
r(Groves) = R(free) + beta*(R(market) - R(free)) + RP
Where:
R(free) = 9.3%
beta = 1.45
R(market) = 13.5%
RP = 5% (the expected growth rate of the dividend)
r(Groves) = 9.3% + 1.45*(13.5% - 9.3%) + 5% = 15.4%