Suppose Stark Ltd. just issued a dividend of $1.91 per share on its common stock

Question

Suppose Stark Ltd. just issued a dividend of $1.91 per share on its common stock. The company paid dividends of $1.60, $1.66, $1.73, and $1.84 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? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Cost of equity %

What if you use the geometric average growth rate? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Cost of equity %

Explanation / Answer

Dividend in year 0=1.6
year 1=1.66
year 2=1.73
year 3=1.84
year 4 =1.91

% change in last 4 years is:

(1.66/1.6)-1 =3.75%
(1.73/1.66)-1=4.22%
(1.84/1.73)-1=6.36%
(1.91/1.84)-1=3.8%

Arithmetic mean=average(3.75.4.22.6.36.3.8)=4.53%
Geometric mean=[((1+3.75%)*(1+4.22%)*(1+6.36%)*(1+3.8%))^(1/4)]-1=4.53%

price= D1*(1+g)/(k-g)
D1=1.91
g=4.53%
price=45

k=8.97%

same for both arithmetic and geometric mean

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