Question

(Individual or component costs of capital) Compute the cost of capital for the firm for the following:

A new common stock issue that paid a $1.77 dividend last year. The firm's dividends are expected to continue to grow at 8.4 percent per year, forever. The price of the firm's common stock is now $27.61.

Answer 1

Solution:
	Cost of capital = 15.35%
Working Notes:
	Using Gordon growth model : P0 = D1 / (Ke - g), where D1 = D0(1+g)
		ke = cost of Equity/ Capital
		Po=current share price = $27.61 per share
		g= growth rate= 8.40% = 0.084
		D0= Current Dividend=$1.77 per share
		P0 = D0(1+g)/(Ke -g)
		Ke=(D0(1+g)/P0) + g
		=(1.77(1+0.084)/27.61) + 0.084
		=0.153492213
		=0.1535
		=15.35%
Notes:	Since the firm is all equity firm there is debt , hence cost of equity is cost of capital for the firm.
Please feel free to ask if anything about above solution in comment section of the question.