Question

The Absolute Zero Co. just issued a dividend of $3.40 per share on its common stock. The company is expected to maintain a constant 4.5 percent growth rate in its dividends indefinitely.
If the stock sells for $53 a share, what is the company’s cost of equity?

Answer 1

Answer:

The company's cost of equity is: 11.20%

Explanation:

The company cost of equity is the discount rate at which present value of the growing perpetuity which is the stock's dividend stream will be equal to its current stock's price.

The present value of the perpetuity, in which r is the cost of equity, is: ( 3.4 x 1.045) / ( r - 0.045);

As explained above, current stock price is equal to the present value of dividend stream being discounted at cost of equity:

=>  ( 3.4 x 1.045) / ( r - 0.045) = 53 <=> r - 0.045 = 0.067 <=> r = 0.067 + 0.045 <=> r = 11.20%.