Question

Rivoli Inc. hired you as a consultant to help estimate its cost of capital. You have been provided with the following data: D0 = $0.80; P0 = $57.50; and g = 8.00% (constant). Based on the DCF approach, what is the cost of equity from retained earnings? Do not round your intermediate calculations.

a. 7.98%
b. 11.02%
c. 10.17%
d. 10.07%
e. 9.50%

Answer 1

e. 9.50%

Step-by-step explanation:

DCF formula for cost of equity =

r = (D1/P0) +g

D1 = Next year's dividend = D0(1+g) = 0.80(1.08) = 0.864

P0 = Current stock price = 57.50

g = dividend growth rate = 8% or 0.08

Next, plug in the numbers to the above DCF formula;

r = (0.864 / 57.5) + 0.08

r = 0.01503 + 0.08

r = 0.095 or 9.5%

Therefore, the cost of equity is 9.50%