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. −2.03%
b. −2.23%
c. −1.66%
d. −1.49%
e. −1.84%
The change in cost is computed as shown below:
= Do ( 1 + growth rate ) / Current stock price + growth rate
= $ 0.85 ( 1 + 0.06 ) / $ 22 + 0.06
= 10.09 % Approximately
Rate if stock price will be $ 40 is computed as follows:
= Do ( 1 + growth rate ) / Current stock price + growth rate
= $ 0.85 ( 1 + 0.06 ) / $ 40 + 0.06
= 8.25 % Approximately
So the change will be:
= 8.25% - 10.09%
= - 1.84%
So the correct answer is option e i.e. - 1.84%
Feel free to ask in case of any query relating to this question
The CEO of Harding Media Inc. as asked you to help estimate its cost of common...
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