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##### Stock in CDB Industries has a beta of .90. The market risk premium is 7 percent,

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Stock in CDB Industries has a beta of .90. The market risk premium is 7 percent, and T-bills are currently yielding 3.5 percent. CDB’s most recent dividend was \$1.80 per share, and dividends are expected to grow at a 5 percent annual rate indefinitely. If the stock sells for \$47 per share, what is your best estimate of CDB’s cost of equity?

Apr 13th, 2015

Solution.

Cost of Equity per CAPM: E(r) = RFR + ß(Rmkt - RFR)
E(r) = 3.5 + 0.90(7) = 9.8%

Cost of Equity using Gordon Growth
P0 = D1 / (r - g)
\$47 = \$1.80(1.05) / (r - 0.05)
1.89 / 47 = r - 0.05
0.04021 + 0.05 = r
r = 0.09021, or 9.02% < this is the rate at which the Market is valuing CDB's equity but you would expect it to move toward the( CAPM) rate

Market value rate plots below the( SML) (less than the  ( CAPM rate) the stock But I would choose the (CAPM)rate because( CAPM) (via Beta) gives you an historic view of volatility.

At the CAPM rate, the stock would be valued at:
P0 = 1.89 / (0.098 - 0.05)
= \$39.38,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,anse

Apr 13th, 2015

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Apr 13th, 2015
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Apr 13th, 2015
Dec 4th, 2016
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