Q. Estimate the future cost of equity (r E ) using the Dividend Growth Model. (a
ID: 2749596 • Letter: Q
Question
Q. Estimate the future cost of equity (rE) using the Dividend Growth Model.
(a) 3 year Dividend growth rate (g) ( the growth rate over 3 years, calculated as the annualized rate of growth between the current year’s dividend per share and the dividend per share 3 years prior) = 17.88% convert the three year growth rate to an effective quarterly rate dividend growth rate
Cash Dividend (D0)= 0.3125, Stock Price (P0)=75.78
(b) Using the information above to calculate the quarterly cost of equity using the dividend growth model.
(c) Use the quarterly cost of equity to find the effective annual cost of equity.
Explanation / Answer
Stock price = D1÷(r-g)
D1 is next expected dividend
r is cost of equity
g is growth rate
a)
Quarterly growth rate, g = 4.47% (17.88%÷4)
b)
$75.78 = $0.3125×(1+4.47%)÷(r-4.47%)
Cost of equity, r = 4.9%
c)
Effective annual cost of equity 19.6% (4.9%×4)
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