Question

The CEO of Harding Media Inc. as asked you to help estimate its cost of common equity. You have obtained the following data: D 0 = $0.85; P0 = $22.00; and dividend growth rate = 6.00% (constant). The CEO thinks, however, that the stock price is temporarily depressed, and that it will soon rise to $40.00. Based on the dividend growth model, by how much would the cost of common from reinvested earnings change if the stock price changes as the CEO expects? a. −1.49% b. −2.03% c. −1.84% d. −2.23% e. −1.66%

Answer 1

c. −1.84%

Step-by-step explanation:

the dividend growth model:

P₀ = Div₁ / (Re - g)

currently

• P₀ = 22
• Div₁ = 0.85 x 1.06 = 0.901
• g = 0.06

22 = 0.901 / (Re - 0.06)

Re - 0.06 = 0.901 / 22 = 0.041

Re = 0.041 + 0.06 = 0.1009 = 10.09%

if stock price increases to $40, then

40 = 0.901 / (Re - 0.06)

Re - 0.06 = 0.901 / 40 = 0.0225

Re = 0.0225 + 0.06 = 0.0825 = 8.25%

decrease in Re = 8.25% - 10.09% = -1.84%