Question

IBM expects to pay a dividend of $2 next year and expects future dividends and earnings to grow at 9% a year in perpetuity. The price of IBM is $100 per share. What is IBM's cost of equity capital

Answer 1

Cost of equity = 11%

Step-by-step explanation:

Cost of equity can be ascertained using the dividend valuation model. The model states that the price of a stock is the present value of future dividends discounted at the required rate of return.

Cost of equity (Ke) =( Do( 1+g)/P ) + g

g- growth rate in dividend, P- price of the stock

g - 9%, P - 100, D(1+g)= 2

D(1+g) represents the dividend payable in year 1 and is already given as 2

Cost of equity = (2/100 + 0.09)× 100

Cost of equity = 11%