HighGrowth Company has a stock price of $20. The firm will pay a dividend next year of $1, and its dividend is expected to grow at a rate of 4% per year thereafter.
What is your estimate of HighGrowth's cost of equity capital?
Cost of Equity:
According to the discounted cash flow approach, the cost of equity is the discount rate that equates the present value of future dividends to its current price. If dividends grow at a constant rate, then the cost of equity is the sum of dividend growth rate and dividend yield.
Answer and Explanation:
We can use the dividend growth model to compute the cost of equity as follows:
- cost of equity = next dividend / current price + dividend growth rate
- cost of equity = 1 / 20 + 4%
- cost of equity = 9%
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Learn more about this topic:
from Finance 101: Principles of FinanceChapter 14 / Lesson 3