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6506 1955 estimatingthecostofequity

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Unformatted text preview: r company has an equity beta of . 58 and the current risk­free rate is 6.1%. If the expected market risk premium is 8.6%, what is your cost of equity capital? Ks = 6.1 + .58(8.6) = 11.1% Since we came up with similar numbers using both the dividend growth model and the SML approach, we should feel pretty good about our estimate Advantages and Disadvantages of Advantages and Disadvantages of SML Advantages Explicitly adjusts for systematic risk Applicable to all companies, as long as we can estimate beta Disadvantages Have to estimate the expected market risk premium, which does vary over time Have to estimate beta, which also varies over time We are using the past to predict the future, which is not always reliable Another Example – Cost of Equity Another Example – Cost of Equity Suppose our company has a beta of 1.5. The market risk premium is expected to be 9% and the current risk­free rate is 6%. We have used analysts’ estimates to determine that the market believes our dividends will grow at 6% per year and our last dividend was $2. Our stock is c...
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