Question

The market price of a share of common stock is $55. The dividend just paid is $3, and the expected growth rate is 4%. Using the Dividend Growth Model, calculate the cost of internal equity.

Answer 1

r = 0.09672 or 9.672%

Step-by-step explanation:

Using the constant growth model of dividend discount model, we can calculate the price of the stock today. The DDM values a stock based on the present value of the expected future dividends from the stock. The formula for price today under this model is,

P0 = D0 * (1+g) / (r - g)

Where,

D0 is the dividend paid recently

D0 * (1+g) is dividend expected for the next period /year

g is the growth rate

r is the required rate of return or cost of equity

55 = 3 * (1+0.04) / (r - 0.04)

55 * (r - 0.04) = 3.12

55r - 2.2 = 3.12

55r = 3.12 + 2.2

r = 5.32 / 55

r = 0.09672 or 9.672%