Question

g Estimate the cost of common equity for a firm, given the following information. For the next year, the firm plans to pay a dividend of $8.76 per share. The firm's stock is trading at $100.81 per share. The expected growth rate of the dividend is 3.8% per year. The firm's tax rate is 27%. (Enter your answer as an annual % rate (APR), rounding to 2 places, e.g., 12.34)

Answer 1

The cost of equity is 12.49 percent

Step-by-step explanation:

The price per share of a company whose dividends are expected to grow at a constant rate can be calculated using the constant growth model of the DMM. The DDM bases the price of a stock on the present value of the expected future dividends from the stock. 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 cost of equity
• g is the growth rate in dividends

As we already know the P0 which is price today, the D1 and the growth rate in dividends (g), we can plug in the values of these variables in the formula to calculate the cost of equity (r)

100.81 = 8.76 / (r - 0.038)

100.81 * (r - 0.038) = 8.76

100.81r - 3.83078 = 8.76

100.81r = 8.76 + 3.83078

r = 12.59078 / 100.81

r = 0.12489 or 12.489% rounded off to 12.49%