National Home Rentals has a beta of 1.06, a stock price of $17, and recently paid an annual dividend of $.92 a share. The dividend growth rate is 2.2 percent. The market has a rate of return of 11.2 percent and a risk premium of 7.3 percent. What is the estimated cost of equity using the average return of the CAPM and the dividend discount model?

Question

Business

Jasmin Hodges

27 September, 11:05

National Home Rentals has a beta of 1.06, a stock price of $17, and recently paid an annual dividend of $.92 a share. The dividend growth rate is 2.2 percent. The market has a rate of return of 11.2 percent and a risk premium of 7.3 percent. What is the estimated cost of equity using the average return of the CAPM and the dividend discount model?

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Answers (1)

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Aryanna Day · Answer 1

9.6845%

Explanation:

Market risk premium = Market return - Risk free rate

7.3 = 11.2 - Risk free rate

Risk free rate = 3.9%

(1) Use CAPM:

Cost of equity = Risk free rate + Beta * Market risk premium

= 3.9% + 1.06 (7.3)

= 11.638%

(2) Use DDM:

Stock price = [Latest dividend * (1 + dividend growth rate) ] : (Cost of equity-dividend growth rate)

$17 = [0.92 (1 + 0.022) ] : (Cost of equity - 0.022)

Cost of equity = 7.731%

Cost of equity = average value from using DDM and CAPM

Cost of equity = 0.5 (7.731 + 11.638)

= 9.6845%