Question

Summerdahl Resort’s common stock is currently trading at $36 a share. The stock is expect- ed to pay a dividend of $3.00 a share at the end of the year (D1 5 $3.00), and the dividend is expected to grow at a constant rate of 5% a year. What is its cost of common equity?

Answer 1

The cost of common equity is 13.33%

Step-by-step explanation:

The price of a stock whose dividends are growing at a constant rate can be calculated using the constant growth model of Dividend Discount Model approach. The formula for price today under this model is,

P0 = D1 / r - g

Where,

• D1 is the dividend expected for the next period
• r is the required rate of return
• g is the growth rate in dividends

As we know the D1, the price today and the growth rate, we can plug in these values in the formula to calculate the required rate of return or the cost of equity.

36 = 3 / (r - 0.05)

36 * (r- 0.05) = 3

36r - 1.8 = 3

36r = 3 + 1.8

r = 4.8 / 36

r = 0.1333 or 13.33%

Answer 2

Cost of common equity is 0.1333 or 13.3%

Step-by-step explanation:

P= D1/(r-g)

D1=3.00

g= 0.05

P=36

Here we have ,

3.00/(r-0.05) = 36

r-0.05= 3/36= 0.08333

r= 0.1333= 13.33%