标题: Cost of equity capital approaches [打印本页] 作者: burning0spear 时间: 2011-7-13 16:26 标题: 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?作者: Londonrocks 时间: 2011-7-13 16:26
I would reckon that if neither method was being asked, the information given will provide the hint.
Worse case scenario would be to do both and see which matches with the answer. I believe this would be a black swan event.
