1. Underestimated Inc.’s common shares currently sell for $40 each. The firm’s m
ID: 2754848 • Letter: 1
Question
1. Underestimated Inc.’s common shares currently sell for $40 each. The firm’s management believes that its shares should really sell for $47 each. The firm just paid an annual dividend of $2 per share and management expects those dividends to increase by 4 percent per year forever (and this is common knowledge to the market).
What is the current cost of common equity for the firm? (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answer to 2 decimal places, e.g. 15.25%.)
The current cost of common equity for the firm= .........%
2. Whitewall Tire Co. just paid an annual dividend of $1.45 on its common shares. If Whitewall is expected to increase its annual dividend by 6.20 percent per year into the foreseeable future and the current price of Whitewall’s common shares is $19.16, what is the cost of common stock for Whitewall? (Round answer to 2 decimal places, e.g. 15.25%.)
Cost of common equity= ....%
Explanation / Answer
1. cost of equity = [current dividend( 1 + growth rate) / Market price] + growth rate
= [$2 ( 1 + 0.04) / $47 ] + 0.04
= $2.08 / $47 + 0.04
= 0.0843
cost of equity = 8.43%
2. cost of equity = [$1.45( 1 + 0.062) / $19.16 ] + 0.062
= $1.5399 / $19.16 + 0.062
= 0.1424
cost of equity = 14.24%
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