Question

2. The Muse Company just issued a dividend of $2.75 per share on its common stock. The company will maintain a 5.8% dividend growth indefinitely. The stock is selling for $59.00 per share. What is the company’s cost of equity?

Answer 1

The cost of equity is 10.73%

Step-by-step explanation:

The cost of equity or required rate of return is the return that investors expect from the stock based on the stock's risk. The company pays a dividend that will grow constantly, so the constant growth model of DDM will be used. The formula for price using constant growth model is,

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

Where,

• D0 * (1+g) is the D1 or the dividend expected for the next period
• r is the cost of equity
• g is the growth rate in dividends

Thus,

59 = 2.75 * (1+0.058) / (r - 0.058)

59 * (r - 0.058) = 2.9095

59r - 3.422 = 2.9095

59r = 2.9095 + 3.422

r = (2.9095 + 3.422) / 59

r = 0.1073 or 10.73%