Question

Sandhill Inc's common shares currently sell for $31 each. The firm's management believes that its shares should really sell for $40 each. The firm just paid an annual dividend of $2 per share and management expects those dividends to increase by 4 percent per year forever (and this is common knowledge to the market). (a1) Correct Answer Your Answer What is the current cost of common equity for the firm? (Round final answer to 2 decimal places, e.g. 15.25%. The current cost of common equity for the firm 10.71 (a2) What does management believe is the correct cost of common equity for the firm? (Round final answer to 2 decimal places, e.g. 15.25%.) Cost of common equity (as per firm's belief)

Answer 1

Year 1 dividend = 2 (1 + 4%) = 2.08

a)

Current cost of common equity for the firm = (D1 / price) + growth rate

Current cost of common equity for the firm = (2.08 / 31) + 0.04

Current cost of common equity for the firm = 0.067097 + 0.04

Current cost of common equity for the firm = 0.1071 or 10.71%

b)

Current cost of common equity as per firm's belief= (D1 / price) + growth rate

Current cost of common equity as per firm's belief = (2.08 / 40) + 0.04

Current cost of common equity as per firm's belief = 0.052 + 0.04

Current cost of common equity as per firm's belief = 0.092 or 9.20%