Question 2

The stock of ZZ Ltd. has a beta of 1.5. The company just paid a dividend of $1.0, and the dividend is expected to grow at 5% per year, indefinitely. The expected market return is 10%, and the risk-free is 5%. The most recent stock price for ZZ is $50.

a. Calculate the cost of equity using the DDM method.

b. Calculate the cost of equity using the SML method.

c. Why are your estimates (in [a] and [b]) are so different?