Suppose Powers Ltd. just issued a dividend of $2.47 per share on its common stoc

Question

Suppose Powers Ltd. just issued a dividend of $2.47 per share on its common stock. The company paid dividends of $1.97, $2.04, $2.21, and $2.31 per share in the last four years.

If the stock currently sells for $66, what is your best estimate of the companys cost of equity capital using arithmetic and geometric growth rates

Geometric dividend growth rate %

Suppose Powers Ltd. just issued a dividend of $2.47 per share on its common stock. The company paid dividends of $1.97, $2.04, $2.21, and $2.31 per share in the last four years.

Explanation / Answer

dividend growth rate
Year-3 = (2.04-1.97)/1.97 = 3.55%
Year-2 = (2.21-2.04)/2.04 = 8.33%
Year-1 = (2.31-2.21)/2.21 = 4.52%
Year 0 = (2.47-2.31)/2.31 = 6.93%

(a) artithmetic average = (3.55+8.33+4.52+6.93)/4= 5.83%
Let g = dividend growth rate
Stock price = Dividend(1+g) / (Cost of Equity-g)
65 = 2.47(1+5.83%) / (Cost of Equity-5.83%)
Cost of Equity = 2.47(1+5.83%)/65+5.83%

=9.85%

(b) geometric average = (3.55%*8.33%*4.52%*6.93%)^(1/4) = 5.52%
Stock price = Dividend(1+g) / (Cost of Equity-g)
65 = 2.47(1+5.52%) / (Cost of Equity-5.52%)
Cost of Equity = 2.47*(1+5.52%)/65+5.52%

=9.53%

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