Question

S. Bouchard and Company hired you as a consultant to help estimate its cost of capital. You have obtained the following data: D0 = $0.85; P0 = $22.00; and g = 6.00% (constant). The CEO thinks, however, that the stock price is temporarily depressed, and that it will soon rise to $34.00. Based on the DCF approach, by how much would the cost of equity from retained earnings change if the stock price changes as the CEO expects? Do not round your intermediate calculations.

Answer 1

Difference = -1.45%

Step-by-step explanation:

As per the data given in the question,

Old price New price

D0 $0.85 $0.85

P0 $22.00 $34.00

g 6.00% 6.00%

D1 = D0 × (1+g) $0.901 $0.901

rs = D1 ÷P0 + g 10.10% 8.65%

We can calculate the difference by using following formula:

Difference = rs (old price) - rs1 (New price)

By putting the value, we get

= 8.65% - 10.10%

= -1.45%