Question

the shoe outlet has paid annual dividends of $.65, $.70, $.72, and $.75 per share over the last four years, respectively. the stock is currently selling for $9a share. what is this firm's cost of equity?

Answer 1

The cost of equity for The Shoe Outlet, estimated using an approximated growth rate of dividends and the Dividend Discount Model, is approximately 13.46%.

Step-by-step explanation:

The cost of equity of The Shoe Outlet can be estimated using the Dividend Discount Model (DDM), assuming a constant growth rate. This model is suitable as the dividends have been growing steadily over the last four years. However, with the information provided, we cannot directly apply the DDM because we do not have the growth rate of the dividends. Typically, the DDM formula to estimate the cost of equity is:

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

Since the growth rate is not specified, we will have to estimate it based on past dividends. Let's assume the dividend grows at a stable rate. The growth rate (g) can be approximately calculated using the past dividends

g ≈ ((Dividend Year 4 - Dividend Year 1) / Dividend Year 1) / Number of Years
g ≈ (($0.75 - $0.65) / $0.65) / 3
g ≈ 0.0513 or 5.13%

Using the last dividend as the next year's dividend and the calculated growth rate, the estimated cost of equity would be:
Cost of Equity ≈ ($0.75 / $9) + 0.0513
Cost of Equity ≈ 0.0833 + 0.0513
Cost of Equity ≈ 0.1346 or 13.46%

This calculation is an approximation and assumes the growth rate stays consistent, which in reality, may not be the case. Investors typically require other financial information and analyses to arrive at a more accurate figure.