Question

Mackenzie Company has a price of $ 31 and will issue a dividend of $ 2.00 next year. It has a beta of 1.5 the​ risk-free rate is 5.7 % and the market risk premium is estimated to be 4.8 %

a. Estimate the equity cost of capital for Mackenzie.

b. Under the​ CGDM, at what rate do you need to expect​ Mackenzie's dividends to grow to get the same equity cost of capital as in part ​(a​)?

Answer 1

(a)-Equity cost of capital for Mackenzie.

As per Capital Asset Pricing Model [CAPM], The cost of common equity is computed by using the following equation

The Cost of Common Equity = Risk-free Rate + [Beta x Market Risk Premium]

Here, we’ve Risk-free Rate (Rf) = 5.70%

Market Risk Premium (Rm – Rf) = 4.80%

Beta of the Stock = 1.5

Therefore, the Cost of Common Equity = Risk-free Rate + [Beta x Market Risk Premium]

= 5.70% + [1.5 x 4.80%]

= 5.70% + 7.20%

= 12.90%

“Equity cost of capital for Mackenzie = 12.90%”

(b)-Dividend Growth Rate

As per Constant Growth Dividend Model (CGDM), the Cost of Equity = [D1 / P0] + g

Here, we’ve Dividend in next Year (D1) = $2.00 per share

Current Share Price (P0) = $31.00 per share

Cost of Equity = 12.90%

Therefore, the Cost of Equity = [D1 / P0] + g

0.1290 = [$2.00 / $31.00] + g

0.1290 = 0.0645 + g

g = 0.1290 – 0.0645

g = 0.0645 or

g = 6.45%

“Hence, the Dividend Growth Rate = 6.45%”