Question

judy's boutique just paid an annual dividend of $2.83 on its common stock. the firm increases its dividend by 3.55 percent annually. what is the company's cost of equity if the current stock price is $40.36 per share? multiple choice 9.98% 11.20% 10.81% 10.27% 10.56%

Answer 1

Judy's Boutique's cost of equity, calculated using the Gordon Growth Model, is 10.81%.

Step-by-step explanation:

To calculate the company's cost of equity, we can use the Gordon Growth Model, which is also known as the Dividend Discount Model (DDM). The model is based on the premise that a company's current stock price is equal to the present value of all future dividend payments when those payments are assumed to grow at a constant rate.

Given that Judy's Boutique just paid an annual dividend (D0) of $2.83 and that dividends are expected to increase by 3.55% annually, the next year's dividend (D1) can be calculated by multiplying the current dividend by (1 + growth rate). The formula for the cost of equity (Ke) is then D1/(P0) + g, where P0 is the current stock price ($40.36) and g is the growth rate (3.55%).

Plugging in these numbers, we calculate the next year's dividend: D1 = 2.83 * (1 + 0.0355) = 2.83 * 1.0355 = $2.93 approximately. We then use the formula for the cost of equity: Ke = $2.93/$40.36 + 0.0355, which simplifies to Ke = 0.0726 + 0.0355, or 10.81%. Therefore, the company's cost of equity is 10.81%.