Suppose Powers Ltd. just issued a dividend of $2.53 per share on its common stoc

Question

Suppose Powers Ltd. just issued a dividend of $2.53 per share on its common stock. The company paid dividends of $2.03, $2.10, $2.27, and $2.37 per share in the last four years.

If the stock currently sells for $72, what is your best estimate of the companys cost of equity capital using arithmetic and geometric growth rates? (Do not round intermediate calculations. Enter your answers as a percentage rounded to 2 decimal places (e.g., 32.16).)

Suppose Powers Ltd. just issued a dividend of $2.53 per share on its common stock. The company paid dividends of $2.03, $2.10, $2.27, and $2.37 per share in the last four years.

Explanation / Answer

Observe the following values to calculate the value of the arithmetic dividend growth rate and geometric dividend growth rate:

Dividend this year is 2.53.

The last 4year dividends are 2.03, 2.10, 2.27, and 2.37 respectively.

Selling price of the stock is $72.

Calculate the growth rate on the dividends as follows:

G1 = (2.10-2.03)/2.03 =3.44%

G2 = (2.27-2.10)/2.10 =8.09%

G3 = (2.37-2.27)/2.27 =4.40%

G4 = (2.53-2.37)/2.37 =6.75%

Calculate the arithmetic growth rate as follows:

3.44+8.09+4.40+6.75/4 = 5.67%

Calculate the cost of equity using the dividend discounting model as follows:

=2.53(1+5.67%)/72+5.67%

=5.71%

Calculate geometric growth rate in dividends as follows:

2.53=2.03(1+g)4

=5.74%

Calculate the cost of equity as per geometric dividend growth rate as follows:

2.53*1.0574/72+0.0574

=5.78%

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