Question

A firm’s common stock currently sells for $40 per share. The firm’s next dividend expected to pay is $2 per share on its common stock, and investors expect the dividend to grow indefinitely at a constant rate of 10% per year. What’s the firm’s cost of common stock using DCF approach? (Why is C the correct answer?)

a) 15.5%

b) 9.5%

c)15.0%

d) 15.5%

e) 16.5%

Answer 1

First Ill prove constant growth DDM model

P0 is the current price of stock

D1 is the next year price

r is the cost of equity for the firm or investor required return

g is the growth rate

=> r=(D1/P0)+g

r=(2/40)+0.1

cost of comon stock =15%