Calculating Cost of Equity. The Lo Tech Co. just issued a divident of $2.20 per share on its common stock. The company is expected to maintain a constant 6 percent growth rate in its dividends indefinitely. If the stock sells for $43 a share, what is the company's cost of equity?
Expected Return pg 383 7th edition Corporate Finance
Projected Dividend
Current Dividend X (1 + Growth Rate)
$2.20 X (1 + 0.06)
$2.20 X 1.06
$2.33
Exp Ret = New Dividend/Current Selling Price + Growth Rate
Exp Ret = $2.33 / $43 + 0.06
Exp Ret = 0.0541 + 0.06
Exp Ret = 11.42%
What is the company’s cost of equity? 11.42%
To calculate the cost of equity, we need to use the dividend discount model (DDM). The DDM formula is as follows:
Cost of Equity = Dividend / Stock Price + Growth Rate
Given the information provided:
Dividend = $2.20
Stock Price = $43
Growth Rate = 6% or 0.06
Now let's plug in the values into the formula:
Cost of Equity = $2.20 / $43 + 0.06
Calculating the expression:
Cost of Equity = 0.05116 + 0.06
Cost of Equity = 0.11116 or 11.116%
Therefore, the company's cost of equity is approximately 11.116%.
It's worth mentioning that the cost of equity is the return required by investors to compensate for the risk they are taking when investing in the company's stock.