Question

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

(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.

Homework Answers

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.
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