Question

The earnings, dividends, and stock price of Tenew Technologies, Inc. are expected to grow at 5 percent per year in the future. Tenew’s common stock sells for $75 per share, its last dividend was $10.00.

a. Using the discounted cash flow approach, what is its cost of common equity?

b. If the firm’s beta is 2, the risk-free rate of return is 3 percent, and the average return on the market is 11 percent, what will be the firm’s cost of equity using the SML equation (CAPM approach)?

Answer 1

a. Cost of common equity = (expected dividend / price) + growth rate

= [{ $ 10 * ( 1+ 5%) } / $ 75 ] + 5%

= 19.00%

Hence the correct answer is 19.00%

b. Cost of equity = risk free rate + ( return on market - risk free rate) * beta

= 3% + ( 11% -3%) *2

= 19.00%

Hence the correct answer is 19.00%