ADK Industries common shares sell for $40 per share

ADK Industries common shares sell for $40 per share. ADK expects to set their next annual dividend at $1.75 per share. If ADK expects future dividends to grow at 7 percent per year, indefinitely, the current risk-free rate is 4 percent, the expected rate on the market is 11 percent, and the stock has a beta of 1.2, what should be the best estimate of the firm’s cost of equity, by taking an average of the 2 estimates?

Step 1: Find the cost of equity using constant-growth formula: 1.75/40 + 0.07 = 11.38 percent.
Step 2: Find the cost of equity using CAPM: 4 + 1.2(11 − 4) = 12.4 percent.
Step 3: Find the average of the two estimates: 11.89 percent.

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