Question

HighGrowth Company has a stock price of $17. The firm will pay a dividend next year of $1.15​, and its dividend is expected to grow at a rate of 4.2% per year thereafter. What is your estimate of​ HighGrowth's cost of equity​ capital? (Round to one decimal place.)

Answer 1

Using the Dividend Discount Model, the estimated cost of equity capital for HighGrowth Company is 11.0%, calculated by dividing the expected dividend by the current stock price and adding the constant growth rate of the dividend.

Step-by-step explanation:

The student is asking how to estimate HighGrowth Company's cost of equity capital which is the return required by investors to compensate them for the risk of investing in the stock.

To estimate the cost of equity for HighGrowth Company, we will use the Dividend Discount Model (DDM), assuming constant growth of dividends. The formula to calculate the cost of equity (r) is given by:

r = (D1/P0) + g

Where:

• D1 is the dividend expected next year, which is $1.15.
• P0 is the current stock price, which is $17.
• g is the expected dividend growth rate, which is 4.2% or 0.042 in decimal form.

Plugging these values into the formula, we get:

r = (1.15/17) + 0.042

r = 0.0676 + 0.042

r = 0.1096 or 10.96%

After rounding to one decimal place, HighGrowth's cost of equity capital is estimated to be 11.0%.