Floyd Industries stock has a beta of 1.20. The company just paid a dividend of $.50, and the dividends are expected to grow at 6 percent per year. The expected return on the market is 11 percent, and Treasury bills are yielding 5.9 percent. The most recent stock price for the company is $76.

Required:
a. Calculate the cost of equity using the DDM method.
b. Calculate the cost of equity using the SML method.

Using the constant growth model of dividend discount model, we can calculate the price of the stock today. The DDM values a stock based on the present value of the expected future dividends from the stock. The formula for price today under this model is,

P0 = D0 * (1+g) / (r - g)

Where,

D0 * (1+g) is dividend expected for the next period /year

g is the growth rate

r is the required rate of return or cost of equity

Plugging in the values for P0, D0 and g in the formula, we can calculate the value of r to be,

76 = 0.5 * (1+0.06) / (r - 0.06)

76 * (r - 0.06) = 0.53

76r - 4.56 = 0.53

76r = 0.53 + 4.56

r = 5.09 / 76

r = 0.06697 or 6.697% rounded off to 6.70%

.

Using the CAPM, we can calculate the required/expected rate of return on a stock. This is the minimum return required by the investors to invest in a stock based on its systematic risk, the market's risk premium and the risk free rate.

The formula for required rate of return under CAPM is,

r = rRF + Beta * (rM - rRF)

Where,

rRF is the risk free rate

rM is the market return

r = 0.059 + 1.2 * (0.11 - 0.059)

r = 0.1202 or 12.02%