Question

"Parker Company stock is currently selling for $130.00 per share and the firm's dividends are expected to grow at 6 percent indefinitely. Assuming Parker's most recent dividend was $5.50, what is the required rate of return on Parker's stock

Answer 1

Cost of equity = 10.7%

Step-by-step explanation:

We will work out the required rate of return using the the dividend valuation model. The model states that the value of a stock is the present value of the future divided discounted at the cost of equity.

The model is given below:

P = D× (1+g)/(r-g)

P- price of stock, D- dividend payable now, g- growth rate in dividend, r- cost of equity

So we substitute

130 = 5.50× (1+r)/(r-0.06)

cross multiplying

(r-0.06)× 130 = 5.50 × (1+r)

130 r- 7.8 = 5.50 + 5.50r

collecting like terms

130 r - 5.50r=5.50 + 7.8

124.5 r= 13.3

Divide both sides by 124.5

r =13.3 /124.5= 0.1068

r=0.1068 × 100= 10.7%

Cost of equity = 10.7%