The Pierce Co. just issued a dividend of $2.35 per share on its common stock. The company is expected to maintain a constant 5 percent growth rate in its dividends indefinitely. If the stock sells for $44 a share, what is the company's cost of equity? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Cost of equity__________ %

Using the constant growth model of dividend discount model, we can calculate the price of the stock today. The DDM values a stock based on the present value of the expected future dividends from the stock. The formula for price today under this model is,

P0 = D0 * (1+g) / (r - g)

Where,

D0 is the dividend paid recently

D0 * (1+g) is dividend expected for the next period /year

g is the growth rate

r is the required rate of return or cost of equity

To calculate the cost of equity (r), we will plug in the values for P0, D0 and g in the formula,

44 = 2.35 * (1+0.05) / (r - 0.05)

44 * (r - 0.05) = 2.4675

44r - 2.2 = 2.4675

44r = 2.4675 + 2.2

r = 4.6675 / 44

r = 0.106079 or 10.6079% rounded off to 10.61%

ewomazinoade ewomazinoade · Answer 2 · 2021-12-09T15:27:49+01:00

ewomazinoade ewomazinoade

09-12-2021

The company's cost of equity is 10.61%.

The formula that can be used to determine the cost of equity is:

r = [tex]\frac{D_{1} }{P}[/tex] - g

Where:

[tex]D_{1}[/tex] = dividend next year = $2.35 x (1.05) = $2.47

g = growth rate
P = value of the stock = $44

r = [tex]\frac{2.47}{44} + 0.05[/tex] = 10.61%

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