Panhandle Industries, Inc., currently pays an annual common stock dividend of $2.20 per share. The company's dividend has grown steadily over the past nine years from $1.10 to its present level; this growth trend is expected to continue. The company's present dividend payout ratio, also expected to continue, is 40 percent. In addition, the stock presently sells at 8 times current earnings (that is, its P/E multiple is 8).
Panhandle Industries stock has a beta of 1.15, as computed by a leading investment service. The present risk-free rate is 7.0 percent, and the expected return on the stock market is 13.0 percent.
a. Suppose an individual investor feels that 12 percent is an appropriate required rate of return for the level of risk this investor perceives for Panhandle Industries. Using the dividend capitalization model and the Capital Asset Pricing Model approaches, determine whether this investor should purchase Panhandle Industries stock.
b. Calculate the company's cost of equity capital using both the dividend capitalization model approach and the Capital Asset Pricing Model approach.