Suppose Powers Ltd. just issued a dividend of $2.63 per share on its common stoc

Question

Suppose Powers Ltd. just issued a dividend of $2.63 per share on its common stock. The company paid dividends of $2.13, $2.20, $2.37, and $2.47 per share in the last four years.

If the stock currently sells for $82, what is your best estimate of the company’s 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).)

If the stock currently sells for $82, what is your best estimate of the company’s 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).)

Explanation / Answer

To use the arithmetic dividend growth model, we first need to find the growth rate in dividends. So, the increase in dividends each year was: $2.13, $2.20, $2.37, and $2.47 & 2.63
g1 = ($2.20 – 2.13)/$2.13 = 3.28%
g2 = ($2.37 – 2.20)/$2.20 = 7.72%
g3 = ($2.47 – 2.37)/$2.37 = 4.22%
g4 = ($2.63 – 2.47)/$2.47 = 6.47%
So, the average arithmetic growth rate in dividends was:
g = (3.28% + 7.72% + 4.22% + 6.47%)/4 = 5.42%

As per your comment, you have calculated the geometric dividend growth rate which is 8.81%.

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