Question

Suppose Stark Ltd. just issued a dividend of $2.35 per share on its common stock. The company paid dividends of $1.90, $2.09, $2.16, and $2.27 per share in the last four years.

If the stock currently sells for $50, what is your best estimate of the company’s cost of equity capital using the arithmetic average growth rate in dividends? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Cost of equity

%

What if you use the geometric average growth rate? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Cost of equity

%

Answer 1

Growth Rates

Year	Dividend	Dividend growth rate
1	1.9
2	2.09	10.00%
3	2.16	3.35%
4	2.27	5.09%
5	2.35	3.52%

Arthimatic mean of growth rate = 10.00+3.35+5.09+3.52 / 4 = 5.49%

Geometric Mean of growth rate = (1.10*1.0335*1.0509*1.0352)^(1/4) - 1 = 5.46%

Cost of capital if Arthimatic mean of growth rate is used = D₁ / P₀ + g = 2.35*1.0549 / 50 + 5.49% = 10.45%

Cost of capital if Geometric mean of growth rate is used = D₁ / P₀ + g = 2.35*1.0546 / 50 + 5.46% = 10.42%

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