Question

Luna Lemon has just paid an annual dividend of $0.45 per share. Analysts expect the firm's dividends to grow by 5% forever. Its stock price is $34.9. What is Luna Lemon's cost of equity?

Answer #1

Compute the next year’s dividend, using the equation as shown below:

Dividend = Current dividend*(1 + Growth rate)

= $0.45*(1 + 0.05)

= $0.4725

Hence, the next year’s dividend is $0.4725.

Compute the cost of equity, using the equation as shown below:

Cost of equity = (Dividend/ Stock price) + Growth rate

= ($0.4725/ $34.90) + 5%

= 6.353868194%

Hence, the cost of equity is 6.353868194%

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