Suppose Hornsby Ltd. just issued a dividend of $2.60 per share on its common sto

Question

Suppose Hornsby Ltd. just issued a dividend of $2.60 per share on its common stock. The company paid cividends of $2.10, $2.17, $2.34, and $2.44 per share in the last four years If the stock currenty sells for $79, what is your best estimate of the company's cost of equity capital using arithmetic and geometric growth rates? (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.18.) Anthmetic dividend growth rate Geometric dividend growth rate

Explanation / Answer

Growth rate every year,

(2.17-2.10)/2.10 = 3.33%

(2.34-2.17)/2.17 = 7.83%

(2.44-2.34)/2.34 = 4.27%

(2.60-2.44)/2.44 = 6.56%

Arithmetic dividend growth rate = (3.33%+7.83%+4.27%+6.56%)/4 = 5.4975%

Stock price = Dividend * (1+growth rate)/(cost of equity - growth rate)

79 = 2.6 * 1.055/(cost of equity - 0.055)

cost of equity - 0.055 = 2.743/79

cost of equity - 0.055 = 0.0347

cost of equity = 8.97%

Geometric dividend growth rate = (1.0333 * 1.0783 * 1.0427 * 1.0656)1/4 - 1

Geometric dividend growth rate = 1.2381/4 - 1

Geometric dividend growth rate = 1.055 - 1 = 5.48%

Stock price = Dividend * (1+growth rate)/(cost of equity - growth rate)

79 = 2.6 * 1.0548/(cost of equity - 0.0548)

cost of equity - 0.0548 = 2.74/79

cost of equity - 0.0548 = 0.0346

cost of equity = 8.94%

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