Question

Consider the following information for Global Warning Corp. (GW) and Hurricane Epsilon Industrial Complex (HEPIC).

Global Warning has a current price of $55, a US beta of 1.1 and a dividend yield of 5%. HEPIC has a price of $40, a US beta of 0.76 and a dividend yield of 6%. Both Global Warning and Hurricane Epsilon are expected to experience dividend growth rates of 2% and 4% respectively in perpetuity (i.e., forever). Assume both Global Warning and HEPIC are 100% equity financed.

In addition you know that the S&P 500 index is at 22000, the yield on the 3-month Treasury bill is 2% and the equity risk premium is 8%.

	A.	Global Warning has a higher implied cost of capital than Hurricane Epsilon
	B.	Not enough information to know whether Global Warning or Hurricane Epsilon has a higher cost of capital.
	C.	Global Warning and Hurricane Epsilon have the same cost of equity
	D.	Global Warning has a lower implied cost of capital than Hurricane Epsilon
	E.	Global Warning and HEPIC have the same implied cost of capital

Answer 1

Implied cost of capital=Dividend yield+growth rate
Global Warning=5%+2%=7%
Hurricane Epsilon=6%+4%=10%

Global Warning has a lower implied cost of capital than Hurricane Epsilon