Question

Ust issued a dividend of $2.51 per share on its common stock. the company paid dividends of $2.01, $2.17, $2.25, and $2.36 per share in the last four years. if the stock currently sells for $43, what is your best estimate of the company’s cost of equity capital using the arithmetic average growth rate in dividends?

Answer 1

The cost of equity capital for the company, using the arithmetic average growth rate in dividends and the Gordon Growth Model, is estimated to be 6.45%.

Step-by-step explanation:

To estimate the company's cost of equity capital using the arithmetic average growth rate in dividends, we must first calculate the growth rate. The dividends over the past five years were $2.01, $2.17, $2.25, $2.36, and most recently, $2.51. To find the arithmetic average growth rate, we calculate each year's growth rate and then find the average of these.

Here are the yearly growth rates:

• From $2.01 to $2.17, the growth is (($2.17 - $2.01)/ $2.01) = 7.96%
• From $2.17 to $2.25, the growth is (($2.25 - $2.17)/ $2.17) = 3.69%
• From $2.25 to $2.36, the growth is (($2.36 - $2.25)/ $2.25) = 4.89%
• From $2.36 to $2.51, the growth is (($2.51 - $2.36)/ $2.36) = 6.36%

We then calculate the average of these growth rates: (7.96% + 3.69% + 4.89% + 6.36%) / 4 = 5.72%

Having the average growth rate, we can use the Gordon Growth Model (Dividend Discount Model) to estimate the cost of equity capital as:

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

Substitute the given figures:

(($2.51 / $43) + 0.0572) × 100 = 6.45%

This 6.45% is the estimated cost of equity for the company using the arithmetic average growth rate in dividends.