Question

In: Finance

TeachMeFinance has a beta of 0.92. The Treasury bill rate is 5 percent. The market risk...

TeachMeFinance has a beta of 0.92. The Treasury bill rate is 5 percent. The market risk premium is 10 percent. The company paid a $1.8 per share dividend a couple of days ago, and it is planning to increase its dividends at a 7 percent annual rate indefinitely. You also know that the company's shares of stock can now be purchased for $34 per share. Based on the above information, what is your best estimate of TeachMeFinance's cost of equity? (Do not round your intermediate calculations.)


rev: 09_20_2012

12.66%

14.2%

11.33%

13.43%

9.6%

Solutions

Expert Solution

Solution :

Calculation of Cost of equity as per CAPM:

As per the Capital Asset Pricing model (CAPM), Cost of equity is calculated using the following formula:

Cost of equity = (RE) = RF + ?* ( RM – RF )

Where RF = Risk free rate

? = Beta of the stock

RM = Expected market return / Return on market

As per the data given in the question

RF = Risk free rate = Treasury bill rate = 0.05 ; ? = 0.92 ;

Market risk premium = (Risk free rate – Return on market) = (RM - RF )= 0.10

Applying the same in the formula above we have

Cost of equity = (RE) = 0.05 + 0.92 * (0.10)

                                                           = 0.05 + 0.0092 = 0.142 = 14.2 %                                                       

Thus the Cost of equity of the company as per CAPM = 0.142 = 14.2 %.

Calculation of Cost of equity as per Dividend Growth model:

As per the Dividend growth model value of a stock/share = D0 * (1+g) / (Ke – g)

Where D0 = Dividend paid in year 0 or last dividend paid

g = Growth rate

Ke = Cost of Equity

As per the Information given in the question:

D0 = $ 1.8 ; g= 7% ; Value of stock = $ 34 per share

Applying the above values in the formula for value of a stock as per the Dividend Growth model we have:

34 = 1.8 ( 1 + 0.07 ) / (Ke – 0.07)

34 = 1.8 ( 1.07 ) / (Ke – 0.07)

34 = 1.926 / (Ke – 0.07)

34 (Ke – 0.07) = $1.926

(Ke – 0.07) = 1.926/34 = 0.0566

(Ke – 0.07) = 0.0566

Ke = 0.07 + 0.0566 = 0.1266

This Cost of Equity as per Dividend growth model = 12.66 %.

The following are the best estimates of cost of equity of Teach Me Finance:

1. As per CAPM : 14.2 %

2. As per Dividend growth model : 12.66 %


Related Solutions

The Treasury bill rate is 5% and the market risk premium is 8%. Project Beta Internal...
The Treasury bill rate is 5% and the market risk premium is 8%. Project Beta Internal Rate of Return, % P 0.95 14 Q 0.00 12 R 2.00 21 S 0.35 13 T 1.60 23 a. What are the project costs of capital for new ventures with betas of 0.70 and 1.59? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.) b. Which of the capital investments shown above have positive (non-zero) NPV's?...
A company has a beta of 1.5. The risk-free rate of return is 5 percent and...
A company has a beta of 1.5. The risk-free rate of return is 5 percent and the market risk premium is 6 percent. Find the required rate of return on the stock (i.e., the cost of equity capital). b) The firm will pay a dividend of $4.00 per share next year. The firm will increase the dividend payment by $0.50 a share every year for the next 5 years (i.e., years 2 to 6). Thereafter, the dividends are expected to...
1. The Treasury bill rate is 4 percent, and the expected return on the market portfolio...
1. The Treasury bill rate is 4 percent, and the expected return on the market portfolio is 12 percent. Using the capital asset pricing model:b. What is the risk premium on the market?c. What is the required return on an investment with a beta of 1.5?d. If an investment with a beta of .8 offers an expected return of 9.8 percent does it have a positive NPV?e. If the market expect a return of 11.2 percent from Stock X, what...
The common stock of CORPORATION X has a beta of 0.9. The Treasury bill rate is...
The common stock of CORPORATION X has a beta of 0.9. The Treasury bill rate is 4%, and the market risk premium is estimated at 8%. CORPORATION X capital structure is 27% debt, paying an interest rate of 6%, and 73% equity. The debt sells at par. CORPORATION X pays tax at 40%. What is BCCI’s cost of equity capital? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place. What is its WACC?...
Stock ABC has beta of 1.2. The risk-free rate is 5%, and the market expected rate...
Stock ABC has beta of 1.2. The risk-free rate is 5%, and the market expected rate of return is 14%. My estimation shows that the stock of ABC has alpha of 3% over a one-year period horizon. I have $20,000 in my account and I also want to “buy on margin” to buy as much ABC as possible. Initial margin requirement is 50% and I am supposed to pay back 5% annually compounded interest on it. What is the rate...
​​​​​ A stock's beta is 5, the market risk premium is 6%, and the risk-free rate...
​​​​​ A stock's beta is 5, the market risk premium is 6%, and the risk-free rate is 2%. According to the CAPM, what discount rate should you use when valuing the stock? A stock's beta is 1.5, the expected market return is 6%, and the risk-free rate is 2%. According to the CAPM, what discount rate should you use when valuing the stock? You have 2 assets to choose from when forming a portfolio: the market portfolio and a risk-free...
23.Jack Ltd has an equity beta of 1.4, the risk-free rate is 3.4 percent and market...
23.Jack Ltd has an equity beta of 1.4, the risk-free rate is 3.4 percent and market risk premium is 8 percent. The yield to maturity of the firm’s bonds is 7 percent and the debt-equity ratio is 0.5. What is the weighted average cost of capital if the tax rate is 30 percent? Select one: a. 11.37 percent b. 11.65 percent c. 10.94 percent d. 12.60 percent 24. Jack Ltd has a levered cost of equity of 13.84 percent and...
Zetta Company has unleveraged beta 1.3, risk free rate 7% and market risk premium for 5%....
Zetta Company has unleveraged beta 1.3, risk free rate 7% and market risk premium for 5%. The applicable tax rate is 40%. The company needs to finance its new project under two different scenarios. Scenario Debt ratio Interest rate EPS 1 0% 0% $2.40 2 30% 10% $3.40 6. WACC under scenario number 2 equals to * a)12.42% b)11.55% c)13.50% d)14.24% e)None of the above 7. The price per share under scenario number 2 equals to * a)$28.50 b)$26.50 c)$24.30...
Zetta Company has unleveraged beta 1.3, risk free rate 7% and market risk premium for 5%....
Zetta Company has unleveraged beta 1.3, risk free rate 7% and market risk premium for 5%. The applicable tax rate is 40%. The company needs to finance its new project under two different scenarios. Scenario Debt ratio Interest rate EPS 1 0% 0% $2.40 2 30% 10% $3.40 6. WACC under scenario number 2 equals to * a)12.42% b)11.55% c)13.50% d)14.24% e)None of the above 7. The price per share under scenario number 2 equals to * a)$28.50 b)$26.50 c)$24.30...
Assume that the interest rate on a one-year Treasury bill is 5.4 percent and the rate on a two-year Treasury note is 9.0 percent.
Assume that the interest rate on a one-year Treasury bill is 5.4 percent and the rate on a two-year Treasury note is 9.0 percent.(a)If the expected real rate of interest is 2.4 percent, determine the inflation premium on the Treasury bill. (Round answer to 1 decimal place, e.g. 527.5.)(b) Using the expected real rate of interest from Part A, if the maturity risk premium is expected to be zero, determine the inflation premium on the Treasury note. (Round answer to...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT