Question

A company hired you as a consultant to help them estimate its cost of capital. You have been provided with the following data: D1 = $2; P0 = $40; and g = 3% (constant). Based on the constant dividend growth model approach, what is the cost of equity?

Answer 1

8%

Step-by-step explanation:

The formula to compute the cost of common equity under the DCF method is shown below:

= Current year dividend ÷ price + Growth rate

where,

Current year dividend is $2

Price is $40

And, the growth rate is 3%

Now put these values to the above formula

So, the cost of equity would equal to

= $2 ÷ $40 + 3%

= 0.05+ 0.03

= 8%