Question
Which of the following statement(s) is correct about
cost of equity? A. Where earnings, dividends, and equity share price all grow at the same rate, the cost of equity capital may be computed by the dividend growth method. B. When the risk-free rate is added to the market rate of the return, risk premium for the stock is arrived.Solution
The dividend growth model allows the cost of equity to be calculated using empirical values of dividends and market value of the share using the formula: re = D0(1 + g) / P0 + g where g is the growth rate of earnings. The risk premium is calculated as market rate of return less the risk-free rate. Risk premium is used in the CAPM model to calculate the cost of equity.
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