Final answer:
The firm's cost of common equity, calculated using the Gordon Growth Model, is 11.88% when rounded to two decimal places.
Step-by-step explanation:
To solve completely the question of calculating Endor Incorporated's cost of common equity, we will use the Gordon Growth Model (also known as the Dividend Discount Model). This model helps us to determine the required rate of return for a constantly growing dividend. The formula for this model is:
Cost of Equity = (D1 / P0) + g
where:
D1 is the dividend one year from now, which is equal to the current dividend (D0) grown by the growth rate (g),
P0 is the current price of the stock, and
g is the growth rate of the dividends.
Given that Endor Incorporated has just paid a dividend (D0) of $3.43, and the dividends are expected to grow at a constant rate of 3%, we can calculate D1 as follows:
D1 = D0 * (1 + g) = $3.43 * (1 + 0.03) = $3.5339
Now, we use the Gordon Growth Model:
Cost of Equity = (D1 / P0) + g = ($3.5339 / $39.79) + 0.03
After doing the math, we find the Cost of Equity:
Cost of Equity = 0.0888 + 0.03 = 0.1188, or 11.88%.
The firm's cost of common equity is therefore 11.88%, rounded to two decimal places.