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? |

Cost of equity | % |

What if you use the geometric average growth rate? |

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 =
D_{1} / P_{0} + g = 2.35*1.0549 / 50 + 5.49% =
10.45%

Cost of capital if Geometric mean of growth rate is used =
D_{1} / P_{0} + g = 2.35*1.0546 / 50 + 5.46% =
10.42%

Thumbs up please if satisfied. Thanks :)

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