Question

The Drogon Co. just issued a dividend of $2.96 per share on its common stock. The company is expected to maintain a constant 5 percent growth rate in its dividends indefinitely. If the stock sells for $35 a share, what is the company's cost of equity

Answer 1

Answer: 13.88%

Explanation:

The cost of equity can be used along with the variables given to calculate the price of a share using the Gordon Growth model so this can be remodeled to solve for the cost of equity.

Price of stock = (Dividend * (1 + growth rate)) / (cost of equity - growth rate)

35 = (2.96 * (1 + 5%)) / (cost of equity - 5%)

35 = 3.108 / (cost of equity - 5%)

(cost of equity - 5%) * 35 = 3.108

Cost of equity - 5% = 3.108 / 35

Cost of Equity = (3.108 / 35) + 5%

= 13.88%