CFA Practice Question

There are 233 practice questions for this study session.

CFA Practice Question

An analyst gathers the following information about a company and the market:

Current market price per share of common stock: $32.00
Most recent dividend per share paid on common stock: $2.40
Expected dividend payout rate: 40%
Expected return on equity (ROE): 15%
Beta for the common stock: 1.5
Expected return on the market portfolio: 12%
Risk-free rate of return: 4%

Using the dividend discount model approach, the cost of common equity for the company is closest to ______.
A. 16.4%
B. 17.2%
C. 18.1%
Explanation: According to the dividend discount model approach, the cost of common equity is equal to the dividend yield plus the growth rate. In this case, the growth rate is the earnings retention rate times the expected ROE or (1 - dividend payout rate) x expected ROE = 1 - 0.4) x 15% = 9%. The expected dividend = 2.40 x (1 + 0.09) = 2.616. The expected dividend yield = 2.616 / 32 = 8.175%. The cost of common equity = 8.175% + 9.0%.

User Contributed Comments 3

User Comment
asalonga7 Tricking throwing in the beta and WACC figures in
farhan92 I used the formula D/P +g

g=(1-payout ratio)(ROE)

However im not too sure why D was multiplied by 1.09
epfrndz If you don't multiply the last dividend by the growth rate (1.09), you'll get 16.5%.

If you multiply the dividend by the growth rate you'll get 17.18%.
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