An important application of the Dividend Discount Model (DDM) and the CAPM is in regulating public utilities. Suppose the State of Iowa allows MidAmerican to yield a 15% return on equity, and in return, MidAmerican would re-invest 60% of its earnings in its business operations, including improvements on natural gas infrastructure.

MidAmerican is expected to pay $6 dollar per share in dividends one year from now. Answer the following questions.

1. If the risk-free rate is 1%, markets risk premium is 12%, and public utilities on average have of 0.8, use the CAPM to find MidAmericans required rate of return.

2. If MidAmericans cost of capital is exactly what you should find in part (a), find its P/E ratio, assuming DDM is a valid way for valuation.