Calculate the weighted cost of equity for a firm with the following characteristics: (a) Last Dividend--$5.00, (b) Growth Rate—6%, (c) Price of Stock--$125.00 and (d) Weight of Equity Capital—40%
To calculate the weighted cost of equity, you will need to use the dividend discount model (DDM) formula. The DDM formula takes into account the last dividend, the growth rate, and the price of the stock. Here is how you can calculate the weighted cost of equity for the given firm:
Step 1: Calculate the dividend per share (DPS) using the last dividend and the growth rate.
DPS = Last Dividend * (1 + Growth Rate)
= $5.00 * (1 + 6%)
= $5.00 * 1.06
= $5.30
Step 2: Determine the market price per share.
Step 3: Calculate the cost of equity (Ke) using the DDM formula:
Ke = (DPS / Price) + Growth Rate
Ke = ($5.30 / $125) + 6%
= 0.0424 + 0.06
= 0.1024 or 10.24%
Step 4: Calculate the weighted cost of equity (WACC) by multiplying the cost of equity by the weight of equity capital:
WACC = Ke * Weight of Equity Capital
= 10.24% * 40%
= 4.096%
Therefore, the weighted cost of equity for the firm is 4.096%.