Excelsior stock is expected to pay $3.00 per share as its next annual dividend. The firm has a policy of increasing the dividend by 11.0 percent annually. The stock has a market price of $13.65 and a beta of 2.8. The market risk premium is 8.56 percent and the risk-free rate is 4.90 percent. What is the cost of equity?

30.92%

Explanation:

Use CAPM (Capital Asset Pricing Model) to find the cost of equity;

cost of equity; r = risk free rate + Beta (Market Risk Premium)

risk free rate = 4.90% or 0.049 as a decimal

Beta = 2.8

Market Risk Premium = 8.56% or 0.0856 as a decimal

Next, plug in the numbers to the above CAPM formula;

r = 0.049 + 2.8 (0.0856)

r = 0.049 + 0.23968

r = 0.2887 or 28.87%

Therefore, cost of equity using CAPM is 28.87%

Next. find cost of equity using Dividend growth model;

r = (D1/P0) + g

r = (3/13.65) + 0.11

r = 0.2198 + 0.11

r = 0.3298 or 32.98%

Cost of equity using Dividend growth model is 32.98%

Find the average of the two to find the cost of equity of this stock;

= (28.87% + 32.98%) / 2

= 61.85%/2

= 30.92%