Suppose Stark Ltd. just issued a dividend of $2.24 per share on its common stock

Question

Suppose Stark Ltd. just issued a dividend of $2.24 per share on its common stock. The company paid dividends of $1.80, $1.98, $2.05, and $2.16 per share in the last four years.

If the stock currently sells for $45, what is your best estimate of the company’s cost of equity capital using the arithmetic average growth rate in dividends?

What if you use the geometric average growth rate?

Suppose Stark Ltd. just issued a dividend of $2.24 per share on its common stock. The company paid dividends of $1.80, $1.98, $2.05, and $2.16 per share in the last four years.

Explanation / Answer

Calculation of Arithmetic average growth rate:

From 1 to 2 = 1.98 - 1.80 / 1.80 = 10% From 2 to 3 = 2.05 - 1.98 / 1.98 = 3.54%

From 3 to 4 = 2.16 - 2.05 / 2.05 = 5.37% From 4 to 5 = 2.24 - 2.16 / 2.16 = 3.70%

Average = 10 + 3.54 + 5.37 + 3.70 / 4 = 5.65%

Cost of Equity = D1 / P0 + g

D1 = Dividend next Year = 2.24 x 1.0565 = $2.37

Cost of Equity = 2.37 / 45 + 0.0565 = 10.92%

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