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Cost of equity capital : explained

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The following financial information is available on Fargo Fabrics, Inc.:
Current per-share market price = $20.25
Current per-share dividend = $1.12
Current per-share earnings = $2.48
Beta = 0.90
Expected market price premium = 6.4%
Risk-free rate (20-year Treasury bonds) = 5.2%
Past 10 years earning per share:

Year Earnings per share
1 $1.39
2 $1.48
3 $1.60
4 $1.68
5 $1.79
6 $1.95
7 $2.12
8 $2.26
9 $2.40
10 $2.48

This past-earnings growth trend is expected to continue for the foreseeable future. The dividend
payment ratio has remained approximately constant over the past 10 years and is expected to
remain at current levels for the foreseeable future.

Calculate the cost of equity capital using the following methods.
A. The constant growth rate dividend capitalization model approach
B. The Capital Asset Pricing Model approach.

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Solution Summary

The solution explains how to calculate the cost of equity capital using constant growth model and capital asset pricing model

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A. The constant growth rate dividend capitalization model approach

Here the cost of equity is calculated as
Cost of Equity = D1/MP + g
Where D1 is the expected dividend
MP = Market Price
g = growth rate in dividends

To calculate g we are given he past trend in earnings and the growth rate will ...

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