Question

If ABC corporation paid a dividend of $6 per share last year. The stock currently...

If ABC corporation paid a dividend of $6 per share last year. The stock currently sells for $80 per share. You estimate that the dividend will grow steadily at a rate of 6% per year into the indefinite future. What is the cost of equity?

Answer 1

r or cost of equity = 0.1395 or 13.95%

Step-by-step explanation:

Using the constant growth model of dividend discount model, we can calculate the price of the stock today. The DDM values a stock based on the present value of the expected future dividends from the stock. The formula for price today under this model is,

P0 = D0 * 91+g) / (r - g)

Where,

• D0 is the dividend paid last year

• D0 * (1+g) is dividend expected for the next period /year

• g is the growth rate

• r is the required rate of return or cost of equity

Plugging in the values for D0, P0 and g in the formula, we can calculate r to be,

80 = 6 * (1+0.06) / (r - 0.06)

80 * (r - 0.06) = 6.36

80r - 4.8 = 6.36

80r = 6.36 + 4.8

r = 11.16 / 80

r = 0.1395 or 13.95%