Amino Industries common shares sell for $100 per share. Amino expects to set their next annual dividend at $4.00 per share.

Amino Industries common shares sell for $100 per share. Amino expects to set their next annual dividend at $4.00 per share. If Amino expects future dividends to grow at 5 percent per year, indefinitely, the current risk-free rate is 2 percent, the expected rate on the market is 7 percent, and the stock has a beta of 1.5, 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: 4.00/100 + 0.05 = 9.00 percent.
Step 2: Find the cost of equity using CAPM: 2 + 1.5(7 − 2) = 9.5 percent.
Step 3: Find the average of the two estimates: 9.25 percent.

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