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Suppose Nicholas Ltd. just issued a dividend of $.60 per share on its common stock. The company paid dividends of $.35, $.40, $.45 and $.50 per share in the last four years. If the stock currently sells for $10, what is your best estimate of the company's cost of equity capital?

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ahmedgodtrust

Answer:

Growth rate (g) = n-1√(Latest dividend)     - 1

                                     Earliest  dividend

                          = 4-1√($0.50/0.35)   -1  

                         = 3√(1.4286)  -1  

                        = 0.1263 = 12.63%

Cost of equity(Ke) = Do(1+g)/Po + g

                              = $0.60(1+0.1263)/$10 + 0.1263

                              = $0.60(1.1263)/$10 + 0.1263

                              = 0.0068 + 0.1263

                              = 0.1331 = 13.31%

Explanation:

In this case, we need to calculate growth rate using dividend growth model as calculated above. Then, we will calculate cost of equity of the firm on the ground that dividend has been paid.

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