Question

Jansen Corporation has a current stock price of $20. Next years dividend is projected to be $2.00. The payout ratio is 20% and projected ROE is 20%. The cost of equity is

A. 11.2

B. 11.4

C. 11.6

D. None of the above

Answer 1

g (growth rate) = ROE*(1-payout ratio) = 20*(1-0.20) =	16.00%
As per (Constant dividend growth model)
Price of stock = Next expected dividend/(cost of equity-growth rate)
Substituting available figures, we have
20 = 2/(cost of equity-0.16)
Cost of equity = 0.16+2/20 =	26.00%
CHECK:
Price of stock = 2/(0.26-0.16) =	$20.00
Answer: None of the above.
Note: For the constant dividend growth model to be applied, cost of
equity should be greater than the growth rate.
Thus, the answer can be none of the above, even without any working
as all the options for cost of equity are less than the growth rate of 16%.