Question

Assume that A limited paid a dividend of 23.3 cents per share just recently. The shares currently sell for $10.8. You also estimate that the dividend will grow steadily at 2.9 % per year into the indefinite future. What is the cost of capital, ke for A limited? Answer as a percentage accurate to two decimal places (11.32% should be entered as 11.32). Do not enter the % sign.

Answer 1

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Correct Answer: 5.12

Working :

Since the dividend is expected to grow at a constant rate after 1 year, we will use the Gordon Growth model to find the required rate of return.

Gordon Growth Model is given by

P = D1 / ( R - G )

Here,

• P= Current Selling price of the stock
• D1= Dividend for the next year
• G = Constant growth rate
• R = Cost of Capital

Parameters provided in the question=

• P= $ 10.8
• D0= 23.3 cents or = 0.233 Dollars
• G = 2.9% or 0.029
• R =?

First Calculating D1

D1 = Do(1+g)

D1 = 0.233 (1.029)

D1 = 0.2398 Dollars

Substituting the values in the formula.

10.8 = 0.2398 / ( R - 0.029)

=>(R - 0.029) = 0.2398 / 10.8

=> (R - 0.029) = 0.0222

=> (R - 0.029) = 0.0222

=> R = 0.0512 or 5.12 %

Therefore, Cost of Capital= 5.12 % or 5.12(as answer need to be without % sign)