Question

Gangland Water Guns, Inc. is expected to pay a dividend of $2.10 one year from today. If the firm's growth in dividends is expected to remain at a flat 3 percent forever, what is the cost of equity capital for Gangland if the price of its common shares is currently $17.50.

Answer 1

15%

Step-by-step explanation:

Use Dividend discount model to find the required return of equity or cost of equity capital;

Return r formula;

`=(D1)/(P0) +g`

whereby; D1 = Next year's dividend = $2.10

P0 = Current price = $17.50

Growth rate; g = 3% or 0.03 as a decimal

Next, plug in the numbers to the formula above to calculate the cost of equity;

r
`=(2.10)/(17.50) +0.03\\ \\ =0.12+ 0.03`

r = 0.15 or 15%

Therefore, cost of equity is 15%