Rossdale Company stock currently sells for $68.25 per share and has a beta of .85. The market risk premium is 7.10 percent and the risk-free rate is 2.85 percent annually. The company just paid a dividend of $3.45 per share, which it has pledged to increase at an annual rate of 3.10 percent indefinitely. What is your best estimate of the company's cost of equity?

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Meherpuya Meherpuya · Answer 1 · 2024-01-05T13:08:58+01:00

Answer:

The cost of equity can be estimated using the Capital Asset Pricing Model (CAPM). The formula is:

\[ \text{Cost of Equity} = \text{Risk-Free Rate} + \text{Beta} \times \text{Market Risk Premium} \]

First, calculate the market risk premium:

\[ \text{Market Risk Premium} = \text{Market Return} - \text{Risk-Free Rate} \]

\[ \text{Market Return} = \text{Risk-Free Rate} + \text{Market Risk Premium} \]

Now, substitute the given values:

\[ \text{Market Return} = 2.85\% + 7.10\% = 9.95\% \]

\[ \text{Market Risk Premium} = 9.95\% - 2.85\% = 7.10\% \]

Now, apply the CAPM formula:

\[ \text{Cost of Equity} = 2.85\% + (0.85 \times 7.10\%) \]

Calculate the cost of equity using the provided numbers.