The Snow Owl Company just issued a dividend of $3.32 per share on its common stock. The company is expected to maintain a constant 8 percent growth rate in its dividends indefinitely. If the stock sells for $70 a share, what is the company’s cost of equity?Note: Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.Blank.xlsx

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BlackTom AI · Accepted Answer

We begin by identifying the dividend growth model context provided in the question. The dividend is said to grow at a constant rate of g = 8% forever, and the current dividend is D0 = 3.32. In the Gordon growth model, the price today P0 is related to the next period dividend D1 and the cost of equity r by the formula P0 = D1 / (r − g). This means we should first determine D1, which is the dividend expected next year: D1 = D0 × (1 + g) = 3.32 × 1.08 = 3.5856.

Next, plug D1 and g into the Gordon formula rearranged to solve for r: r = (D1 / P0) + g. Substituting the numbers gives r = (3.5856 / 70) + 0.08.

Compute the fraction: 3.5856 / 70 ≈ 0.05122 (approximately 5.122%). Add the growth rate: 0.05122 + 0.08 = 0.13122, i.e., about 13.122%.

Therefore, the cost of equity is approximately 13.12% when rounded to two decimal places. Note that if someone uses a different interpretation for D1 or misapplies the formula (for example, using D0 directly in the numerator or omitting the growth term), they would arrive at a different value such as 12.12% or another incorrect figure. Here, the correct approach strictly follows P0 = D1 / (r − g) with D1 derived from D0 growing at rate g, and r solved accordingly.

Summary of key steps:
- Compute D1 = D0 × (1 + g) = 3.32 × 1.08 = 3.5856.
- Use r = (D1 / P0) + g = 3.5856 / 70 + 0.08 ≈ 0.13122.
- Convert to a percentage: ≈ 13.12%.

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Company ABC’s ordinary shares are currently selling at​ $24.00 per share. The company is expected to pay a dividend of​ $1.92 per share, which is predicted to grow at ​ 4% per annum forever. What is the​ share's expected rate of​ return?

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