Question #122743

Suppose our company has a beta of 1.5. The market risk premium is expected to be 9%, and the current risk-free rate is 6%.

•We have used analysts’ estimates to determine that the market believes our dividends will grow at 6% per year and our last dividend was $2.

•Our stock is currently selling for $15.65. What is our cost of equity?

•We have used analysts’ estimates to determine that the market believes our dividends will grow at 6% per year and our last dividend was $2.

•Our stock is currently selling for $15.65. What is our cost of equity?

Expert's answer

There are two ways to compute the cost of equity:

**Using Security Market Line (SML)**

**E(R**_{i}**) = R**_{f}** + β**_{i }*** [E(R**_{m}**) – R**_{f}**]**

**where**

E(R_{i}) = Expected return on asset

R_{f} = Risk-free rate of return

β_{i} = Beta of asset

E(R_{m}) = Expected market return

=19.5%

The cost is thus approximately 19.5%

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