Question

The Shoe Outlet has paid annual dividends of $.65, $.70, $.72, and $.75 per share over the last four years, respectively. The stock is currently selling for $9a share. What is this firm's cost of equity?

8.74 percent

13.65 percent

10.38 percent

9.53 percent

11.79 percent

Answer 1

Hello

THE CORRECT ANSWER IS OPTION B : 13.65%

Using artithmatic average method :

•To use the dividend growth model, we first need to find the growth rate in dividends. So, the increase in dividends each year was:

g₁ = ($.70 – .65)/$.65 = 7.69%

g₂ = ($.72 – .70)/$.70 = 2.86%

g₃ = ($0.75 – .72)/$.72 = 4.17%

So, the average arithmetic growth rate in dividends was:

• g = (7.69%+2.86%+4.17%)/3 = 4.91%

• Using this growth rate in the dividend growth model, we find the cost of equity is:

• RE = [$0.75(1.0491)/$9.00] + .0491 = 13.65%

I hope this solves your doubt.

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