Chapter 11, Problem 30P

Eaton Electronic Company’s treasurer uses both the capital asset pricing model and the dividend valuation model to compute the cost of common equity (also referred to as the required rate of return for common equity). Assume the following:

$\begin{array}{l}{R}_f=7\%\\ K_m=10\%\\ \text{β}=1.6\\ D_1=\text{\$}.70\\ P_0=\text{\$}19\\ g=8\%\end{array}$

a. Compute $K_i$ (required rate of return on common equity based on the capital asset pricing model).

b. Compute $K_e$ (required rate of return on common equity based on the dividend valuation model).