Question

HHLT Trading, Inc. pays a dividend of $2.50 on $12.50 in earnings per share. If the firm’s return on equity (ROE) is 17.5%. If the company’s common stock is currently trading at $50 per share, what is its cost of equity capital? NOTES: - Do not use the % sign. - Round your answer to the nearest tenth (using 1 decimal space). For example, 8.35% should be entered as 8.4

Answer 1

Current Dividend, D0 = $2.50
Current EPS, EPS0 = $12.50
Current Price, P0 = $50.00

Payout Ratio = D0 / EPS0
Payout Ratio = $2.50 / $12.50
Payout Ratio = 0.20

Retention Ratio, b = 1 - Payout Ratio
Retention Ratio, b = 1 - 0.20
Retention Ratio, b = 0.80

Growth Rate, g = ROE * b
Growth Rate, g = 17.50% * 0.80
Growth Rate, g = 14.00%

Expected Dividend, D1 = D0 * (1 + g)
Expected Dividend, D1 = $2.50 * 1.14
Expected Dividend, D1 = $2.85

Cost of Equity = D1 / P0 + g
Cost of Equity = $2.85 / $50.00 + 0.14
Cost of Equity = 0.0570 + 0.1400
Cost of Equity = 0.1970 or 19.70%

So, cost of equity capital is 19.70%