The Absolute Zero Co. just issued a dividend of $3.20 per share on its common stock. The company...

Question:

The Absolute Zero Co. just issued a dividend of $3.20 per share on its common stock. The company is expected to maintain a constant 6.6% growth rate in its dividends indefinitely.

If the stock sells for $64 a share, what is the company's cost of equity? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Cost of Equity:

The cost of equity for a firm is determined by using various models such as capital asset pricing model, constant dividend growth rate model etc. The various parameters which dictate the cost of equity are the expected growth rate of earnings, beta of the firm's stock and the market risk premium.

Answer and Explanation:

The calculated cost of equity is 6.65%.

The dividend for the next year is given by:

  • = Dividend just issued * (1 + growth rate)
  • = $3.20 * (1 + 6.6%)
  • = $3.20 * 1.066
  • = $3.41

The company's cost of equity is given by:

  • = (Dividend for the next year / current selling price) + growth rate
  • {eq}= \dfrac{\$3.41}{\$64} + 6.6\% {/eq}
  • = 5.33% + 6.6%
  • = 6.65%

Learn more about this topic:

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How to Calculate the Return on Equity: Definition, Formula & Example

from Financial Accounting: Help and Review

Chapter 5 / Lesson 31
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