Question

UNT Inc. is expected to pay a dividend of $1.50 per share at the end of year 1(Div1), and the dividends are expected to grow at a constant rate of 2 percent forever. If the current price of the stock is $30 per share, calculate the expected return or the cost of equity capital for the firm.

Answer 1

The expected return or the cost of equity capital for the firm is 7%.

Step-by-step explanation:

This is calculated by using the Gordon growth model (GGM) formula as follows:

P = Div1/(r - g) ……………………………………… (1)

Where;

P = current price share = $30

Div1 = Expected dividend at the end of year 1 = $1.50

r = expected return = ?

g = dividend constant growth forever = 2%, or 0.02

Substituting the values into equation and solve for r, we have:

30 = 1.50 / (r - 0.02)

30(r – 0.02) = 1.50

30r – 0.60 = 1.50

30r = 1.50 + 0.60

r = (1.50 + 0.60) / 30 = 0.07, or 7%

Therefore, the expected return or the cost of equity capital for the firm is 7%.