Question

# Suppose Powers Ltd. just issued a dividend of \$1.20 per share on its common stock. The...

 Suppose Powers Ltd. just issued a dividend of \$1.20 per share on its common stock. The company paid dividends of \$.85, \$.92, \$.99, and \$1.09 per share in the last four years.
 Required: If the stock currently sells for \$53, what is your best estimate of the company’s cost of equity capital using arithmetic and geometric growth rates? (Do not round intermediate calculations. Enter your answers as a percentage rounded to 2 decimal places (e.g., 32.16).)
 Cost of equity Arithmetic dividend growth rate % Geometric dividend growth rate %

 Cost of equity Arithmetic dividend growth rate 11.48% Geometric dividend growth rate 11.47%

Explanation;

1. Cost of equity (Arithmetic dividend growth rate);

First of all let’s calculate growth rate;

g1 = (\$.92 – \$.85) / \$.85 = 8.24%

g2 = (\$.99 – \$.92) / \$.92 = 7.61%

g3 = (\$1.09 – \$.99) / \$.99 = 10.10%

g4 = (\$1.20 – \$1.09) / \$1.09 = 10.09%

Average arithmetic growth rate will be (8.24 + 7.61 + 10.10 + 10.09) / 4 = 9.01%

Now let’s calculate cost of equity;

Cost of equity [\$1.20 (1.0901) / \$53] + 0.0901

Cost of equity = 11.48%

2. Cost of equity (Geometric growth rate);

First of all let’s calculate growth rate;

\$1.20 = \$.85(1 + g)4

On solving this equation growth rate comes to .0900

Thus, growth rate (g) = 9%

Now let’s calculate cost of capital;

Cost of equity;

Cost of equity [\$1.20 (1.09) / \$53] + 0.09

Cost of equity = 11.47%

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