Question

The earnings, dividends, and stock price of Shelby Inc. are expected to grow at 7% per year in the future. Shelby's common stock sells for $23 per share, its last dividend was $2.00, and the company will pay a dividend of $2.14 at the end of the current year. . Using the discounted cash flow approach, what is is cost of equity? b. If the firm's beta is 1.6, the risk-free rate is 9%, and the expected return on the market is 13%, then what would be the firm's cost of equity based on the CAPM approach?

Answer 1

a) Using DCF approach, we would apply constant growth dividend discount model, according to which

r - 0.07 = 0.0930

r = 16.30%

b) Using CAPM,

Cost of Equity = Risk free rate + Beta * (Expected market return - Risk free rate)

Cost of Equity = 9% + 1.6 * (13% - 9%)

Cost of Equity = 15.40%