Question

Suppose Powers Ltd., just issued a dividend of $1.20 per share on it common stock. The company paid dividends of $.85, $.92, $.99, and $1.09 per share in the last four years. 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?

Answer 1

Answer: 11.48%; 11.47%

Explanation:

Given that,

Dividend Issued on common stock = $1.20 per share

Dividend paid in last four years:

$.85 per share

$.92 per share

$.99 per share

$1.09 per share

Stock currently sells at = $53

Calculation of growth rates in dividends :

G1 = $\frac{0.92-0.85}{0.85}$

    = 8.24%

G2 = $\frac{0.99-0.92}{0.92}$

     = 7.6%

G3 = $\frac{1.09-0.99}{0.99}$

     = 10.1%

G4 = $\frac{1.20-1.09}{1.09}$

     = 10.09%

(1) Arithmetic growth Rate = $\frac{8.24+7.6+10.1+10.09}{4}$

                                           = 9.01%

Cost of Equity = $\frac{(1.20)(1.0901)}{53}+0.0901$

                        = 11.48%

(2) Geometric growth Rate

$1.20=0.85(1+g)^{4}$

G = 9%

Cost of Equity = $\frac{(1.20)(1.09)}{53}+0.09$

                        = 11.47%