Question

Problem 14-1 Calculating Cost of Equity (L01) The Drogon Co. just issued a dividend of $3.40 per share on its common stock. The company is expected to maintain a constant 7 percent growth rate in its dividends indefinitely If the stock sells for $68 a share, what is the company's cost of equity? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Cost of equity

Answer 1

As per dividend capitalisation model,

Cost of equity = (D1/P0)+g

where,

D1= Dividends per share next year

P0= Current share price

g= Dividend growth rate

We know,

Dividend this year (D0)= $ 3.40

Constant growth rate= 7%

Price of share= $68

Therefore, dividend next year would be $ 3.40+ 7%= $ 3.638

So, Cost of equity= (3.638/68)+0.07= 0.1235

Answer= 12.35%