Question

- A company’s stock is currently selling for $80 per share. The company has just paid a dividend of $3.75 per share. Investors expect this dividend to grow at the rate of 9% per year for the next 8 years and at a rate of 3% per year thereafter.

- Calculate the cost of equity for this company.

Answer #1

current stock price (P_{0}) = $80

dividend growth rate for first 8 years (g_{1}) = 9%

From 9th year the dividend growth rate (g_{2}) = 3%

D_{t} = dividend paid in year t

Dividend paid in year 0 i.e. today (D_{0}) = $3.75 per
share

Dividend in year 1 = Dividend in year 0 + ( dividend in year 0 * growth rate * t )

D_{1} = D_{0} + ( D_{0} * g_{1}
* 1)

= $3.75 + ($3.75 * 9% * 1)

= $3.75 + $0.3375

D_{1} = $4.0875

Similarly, D_{8} = D_{0} + ( D_{0} *
g_{1} * 8)

D_{8} = $3.75 + ($3.75 * 9% * 8)

D_{8} = $3.75 + $2.7

D_{8} = $6.45

**Therefore, dividend in year 8 (D _{8}) =
$6.45**

**Cost of equity
(K _{e}) using dividend growth model:**

**K _{e}**
= (Dividend / current stock price) + growth rate

= ( D_{8} / P_{0} ) + g_{2}

= ($6.45 / $80) + 3%

= 0.080625 + 3%

= 8.0625% + 3%

**K _{e}**
= 11.0625%

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