Suppose Hornsby Ltd. just issued a dividend of $2.64 per share on its common sto

Question

Suppose Hornsby Ltd. just issued a dividend of $2.64 per share on its common stock. The company paid dividends of $2.14, $2.21, $2.38, and $2.48 per share in the last four years. If the stock currently sells for $83, what is your best estimate of the company’s cost of equity capital using arithmetic and geometric growth rates? (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

Cost of equity

Arithmetic dividend growth rate %

Geometric dividend growth rate %

Explanation / Answer

Answer)

for Average dividend growth

G1 = (2.21-2.14)/2.14 = 3.271%

G2 = (2.38-2.21) / 2.21 = 7.692%

G3 = (2.48-2.38) /2.38 = 4.202%

G4 = (2.64-2.48)/2.48 = 6.452%

Growth rate (Using Arithematic average) = (3.271%+7.692%+4.202%+6.452%) /4 = 5.404%

Growth rate (Using Geometric Mean)

=( [ (1+0.03271)*(1+0.07692)*(1+0.04202)*(1+0.06452) ]^(1/4) -1 ) = 0.053895 or 5.389%

Now we have calculated the Growth rates using GM and AM , we use these values to calculate the the Cost of equity

Using growth rate from AM

Current price = Expected dividend / ( cost of equity - Growth rate)

83 = 2.64*(1+0.05404) / (K - 0.05404)

K = 8.7567%

Using growth rate from GM

Current price = Expected dividend / ( cost of equity - Growth rate)

83 = 2.64*(1+0.053895) / (K - 0.053895)

K = 8.7417%

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