Question

IPI Research's common stock is currently selling for $45/share. Their most recent dividend (annual) was $2.50, and is expected to grow at 5% per year indefinitely. What is IPI's cost of retained earnings? 10.56% 10.83% 12.14% 13.00% 17.14%

Answer 1

The cost of retained earnings is 10.83%

Step-by-step explanation:

The constant growth model assumes that the dividends grow at a constant rate indefinitely and the DCF approach is used to calculate the price of a stock that has constant dividend growth.

The formula to calculate the Price of such a stock today using the constant growth model is,

P0 = D0 * (1+g) / r - g

We will plug in the values that are known to calculate the required rate of return on such a stock.

45 = 2.5*(1+0.05) / r - 0.05

45 * (r- 0.05) = 2.625

45r - 2.25 = 2.625

45r = 2.625 + 2.25

r = 4.875 / 45

r = 0.1083 or 10.83%