Question

Endor Incorporated has a current stock price of $70.49. The last dividend was at 2.38, and is expected to grow at a 3% constant rate. What is the firm’s cost of common equity? Give your answer as a percentage, rounded to two decimal places (example: 9.58% as 9.58)

Answer 1

Using the Dividend Discount Model with the given stock price, last dividend, and growth rate, the firm's cost of common equity is calculated to be 6.38%.

Step-by-step explanation:

The firm's cost of common equity can be estimated using the Dividend Discount Model (DDM), which is based on the premise that the current stock price reflects the present value of all future dividend payments when those payments are expected to grow at a constant rate. The formula for DDM is:

P = D / (r - g)

where P = current stock price, D = dividend just paid, r = cost of equity, and g = growth rate of dividends. By rearranging the formula to solve for r, we get:

r = (D / P) + g

Substituting the given values:

r = (2.38 / 70.49) + 0.03

After performing the calculation, we find:

r = 0.0338 + 0.03

r = 0.0638 or 6.38%

Therefore, the firm's cost of common equity is 6.38%.