Question

Alderaan Incorporated has a current stock price of $60.67. The last dividend was at 2.12, and is expected to grow at a 5% 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

To calculate Alderaan Incorporated's cost of common equity, use the Gordon Growth Model, which gives a result of 8.49%, demonstrating the required rate of return for the risk taken by investors.

Step-by-step explanation:

To calculate the firm’s cost of common equity for Alderaan Incorporated, we can use the Gordon Growth Model (also known as the Dividend Discount Model). This model is generally expressed as:

Cost of Equity = (Dividends per Share / Current Stock Price) + Growth Rate

This model helps investors determine what rate of return they require to be compensated for the risk they are taking with a particular stock. Using the provided information, the last dividend was $2.12, the current stock price is $60.67, and the constant growth rate is 5%.

To find the cost of common equity, perform the following calculation:

Cost of Equity = ($2.12 / $60.67) + 0.05

Cost of Equity = 0.0349 (or 3.49%) + 0.05

Cost of Equity = 0.0849 (or 8.49%)

Therefore, the firm’s cost of common equity is 8.49%, if rounded to two decimal places.