Question

Suppose Hornsby Ltd. just issued a dividend of $2.53 per share on its common stock. The company paid dividends of $2.03, $2.10, $2.27, and $2.37 per share in the last four years.

If the stock currently sells for $72, what is your best estimate of the company’s cost of equity capital using arithmetic and geometric growth rates?

Answer 1

Geometric Average growth rate

Growth rate for year 1 (g₁) = 3.45%

Growth rate for year 2 (g₂) = 8.10%

Growth rate for year 3 (g₃) = 4.41%

Growth rate for year 4 (g₄) = 6.75%

Geometric Average Growth = [ (1 + g₁) x (1 + g₂) x (1 + g₃) x (1 + g₄) ]^{1 / 4} - 1

or, Geometric Average Growth = [ (1+0.0345) x (1 + 0.081) x (1+ 0.0441) x (1 + 0.0675) ]^{1 / 4} - 1 = 0.056589 or 5.66% (or you can try 5.67% as well)

Cost of Equity = [ $2.53 x (1 + 0.0566) / $72 ] + 0.0566 = 0.09372 or 9.37% (or 9.38%)