has a share price of $154 and an expected EPS of $8 next year. The company currently pays out 100% of earnings as dividends, but is considering a new policy of paying out just 70% of dividends. Retained earnings are expected to earn a return of 5.9%. What is the cost of equity?

Question

Business

Domino

13 January, 08:11

has a share price of $154 and an expected EPS of $8 next year. The company currently pays out 100% of earnings as dividends, but is considering a new policy of paying out just 70% of dividends. Retained earnings are expected to earn a return of 5.9%. What is the cost of equity?

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Kate Harrell · Answer 1

Po = $154

EPS = $8

D1 = 70% x $8 = $5.6

r = 5.9% = 0.059

b = 30% = 0.3

g = b x r

g = 0.3 x 0.059

g = 0.0177 = 1.77%

Ke = D1/Po + g

Ke = $5.6/$154 + 0.0177

Ke = 0.0541 = 5.41%

Explanation:

In this case, we need to calculate the growth rate by multiplying the rate of return (r) by the retention rate (b). Since the pay-out ratio is 70%, the retention rate (b) is 30%. Dividend is 70% of earnings per share. Then, we will calculate the cost of equity by dividing the expected dividend (D1) by the current market price of the share and thus add the growth rate.