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Cost of equity capital approaches
Had a question on the practice test on cost of equity capital. I didnt realize two different methods DDM and CAPM yielded different results.
The following information applies to World Turn Co.
>10% rate of interest on newly issued bonds
>7% growth rate in earnings and dividends
>The last dividend paid was $0.93
>Shares sell for $16
>Stocks beta is 1.5
>Market risk premium is 6%
>Risk free rate of interest is 5%
>The firm is in a 40% marginal tax bracket
If the appropriate risk premium relative to the bond yield is 4%, World Turn's equity cost of capital using the divdend discount model is closest to:
A. 12.8%
B. 13.2%
C. 14.0%
Answer B, 13.2%
The answer was derived using the equation D1/P0 + g,
.93(1.07)/16 + .07 = 13.2%
I calculated this using the cost of equity capital approach
.05 + 1.5(.06) = 14%
My question is, since each of these methods yielded different results, which method would be the best to use in a situation where they do not specify the which method to use? |
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发表于 2011-7-13 16:26
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