The Drogon Co. just issued a dividend of $2.51 per share on its common stock. The company is expected to maintain a constant 6 percent growth rate in its dividends indefinitely. If the stock sells for $40 a share, what is the company's cost of equity?
13.28%
12.65%
6.8%
12.28%
12.02%
Solution: | |||
Answer is 2nd option 12.65% | |||
Working Notes: | |||
We will compute cost of equity of the company using constant growth method of Gordon know as Gordon frowth model. | |||
Using Gordon growth model : P0 = D0(1+g) / (Ke - g) | |||
ke = cost of Equity =?? | |||
Po=current share price = $40 per share | |||
g=constant growth rate= 6% | |||
D0= Just paid Dividend=$2.51 per share | |||
P0 = D0(1+g)/(Ke -g) | |||
Ke = (D0(1+g)/P0) + g | |||
Ke = (2.51 x (1+6%)/40) + 6% | |||
Ke = 6.6515% + 6% | |||
Ke = 12.6515% | |||
Ke = 12.65% | |||
Hence | cost of equity of the company is 12.65% | ||
Please feel free to ask if anything about above solution in comment section of the question. |
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