Question

Last year, Wilderness Adventures paid an annual dividend of $3.70 per share. The firm recently announced that it will increase its dividend by a constant 12.5 percent annually. What is one share of this stock worth today at a required rate of 17.8 percent?

$78.05

$79.63

$78.54

$79.75

Excelor stock is expected to pay $2.80 per share as its next annual dividend. The firm has a policy of increasing the dividend by 10.0 percent annually. The stock has a market price of $13.61 and a beta of 2.6. The market risk premium is 8.54 percent and the risk-free rate is 4.80 percent. What is the cost of equity?

27.71 percent

28.14 percent

29.18 percent

28.79 percent

Answer 1

ANSWER :

Wilderness Adventures Case :

Given :

D₀ = $3.70

g = 12.5 % = 0.125

r = 17.8 % = 0.178

P₀ 

= D₀(1 + g) / (r  -  g) 

= 3.70(1 + 0.125) / (0.178 - 0.125)

= 78.54 ($) 

So, stock is worth today = $78.54 (ANSWER).

Excelor Stock Case :

Given :

D₁ = $2.80

g = 10 % = 0.10

P₀ = 13.61 ($)

b = 2.6

rP = 8.54 % 

rF = 4.80 % 

So, aș per CAPM model :

 Rate of return on equity , rE = rF + b * rP = 4.80 + 2.6 * 8.54 = 27 % = 0.27 = 27% 

As per dividend model :

r = D₁/P₀ + g

= 2.80/13.61 + 0.10

= 0.3057

= 30.57% 

So,

Cost of equity may be taken average of the above two values :

= (27 + 30.57)/2

= 28.79% (ANSWER).

Answer 2

Price of share ={Do × (1+g)} / (Re - g)

Where Do = last year dividend

g = Growth

Re .= Required rate of return

Price of share = ($3.70 × 1.125) / (17.8% - 12.5%)

Price of share = ($4.1625 / 5.30%)

Price of share = $78.54

Hence the answer will be c) $78.54