Underestimated Inc.’s common shares currently sell for $45 each. The firm’s mana
ID: 2793436 • Letter: U
Question
Underestimated Inc.’s common shares currently sell for $45 each. The firm’s management believes that its shares should really sell for $52 each. The firm just paid an annual dividend of $2 per share and management expects those dividends to increase by 2 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______________ %
What does management believe is the correct 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%.) Cost of common equity (as per firm's belief)___________________%
Explanation / Answer
Part - A
Current cost of Commpn Equity of Firm
Cost of Equity = D0(1+g)/PO+g
=2(1.02)/45+0.02
=0.0653 or 6.53%
PART - B
Management believe is the correct of cost of common equity for the firm
Cost of Equity = 2(1.02)/52+0.02
=0.0592 or 5.92%
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