Question

1. ABC Company has a share price of $79 today. If Krell is expected to pay a dividend of $10 at the end of the year and its stock price is expected to grow at $80 at the end of the year. What is the equity cost of capital for the stock? (Round to 4 decimal places. Do not use percentage value)

There is a 1% tolerance for errors. For example, if the correct answer is 1.00, then any number between 0.99 and 1.01 will be correct answers.

Answer 1

Present Value (P0) = $ 79 per share

Future Value (P1) = $ 80 per share

Growth rate in Share price (g) = (80-79) / 79 = 0.01265 or 0.0127

As per Dividend Growth Model

P0 = D1 / Ke-g

79 = 10 / Ke - 0.0127

Ke - 0.0127 = 10/79

Ke = 0.13928 or 0.1393 or 13.93 %

Note : Dividend is taken as $ 10 per share without giving any growth effect, since in the question they have mentioned as Expected Dividend at the end of the year. Hence, growth rate is already included in the Dividend anticipation.

Alternative approach, if Dividend is not growth adjusted

D1 = D0 (1+g)

D1 = 10 (1+0.0127)

D1 = $ 10.127 per share

As per Dividend growth model

P0= D1/Ke-g

79 = 10.127 / Ke - 0.0127

Ke - 0.0127 = 10.127/79

Ke = 0.1409 or 14.09 %