Question

Q2: You have just graduated from MBA program with finance major. Immediately after graduation you have been hired as a financial analyst in a highly prestigious listed company name Cornejo. Your first assignment is to estimate the cost of equity capital and stock price of the company. Your assistant gathered the following information for you:

• The dividend per share (DPS) record of the company over the last 5 years is as follows:

Year	Dividend per Share (DPS)
t-5	7.80
t-4	9.4
t-3	10.85
t-2	11.2
t-1	11.7
t0	10

• Risk free rate is 3.5 percent
• Market risk premium is 5 percent
• Cornejo Co has an estimated beta of 1.10
• The company’s dividend growth rate is expected to remain constant for the foreseeable future.

Required:

1. Estimate the company’s cost of equity capital using CAPM.  
2. Draw and briefly define the security market line (SML).
3. Extrapolate a past growth rate. (
4. Estimate the current price of the company’s shares.
5. State clearly any limitations and assumptions that you made in your calculations.

Answer 1

e) Here the assumption while calculating the price of the stock is the growth rate in the dividend. We have used extrapolation in trend to calculate the dividend at t = 6, and the growth rate at t= 6 is calculated on the basis of dividend from t =5. The limitataion to this approcah is that the future dividend might not grow at the historical rate and dividend might decline.