Question

CafeSi is expected to maintain a constant annual 4% growth rate in its dividends, indefinitely. The company's stock is currently trading at $20 and the company will pay a dividend of $2 per share next year. What is the cost of common equity: Re (or, required rate of return on equity) for CafeSi?

Answer 1

The cost of common equity or the required rate of return on equity (Re) for CafeSi, calculated using the Gordon Growth Model, is 14%.

Step-by-step explanation:

The cost of common equity or required rate of return on equity (Re) for CafeSi can be calculated using the Gordon Growth Model which is based on the following formula: Re = (D1 / P0) + g, where:

• D1 is the expected dividend next year, which is $2.
• P0 is the current stock price, which is $20.
• g is the constant growth rate in dividends, which is 4% or 0.04.

Using the formula gives us: Re = (2 / 20) + 0.04 = 0.10 + 0.04 = 0.14 or 14%. Therefore, the cost of common equity for CafeSi is 14%.