The Down and Out Co. just issued a dividend of $2.41 per share on its common stock. The company is expected to maintain a constant 5 percent growth rate in its dividends indefinitely. If the stock sells for $45 a share, what is the company's cost of equity? (Do not round your intermediate calculations.)

0.1062 or 10.62%

Step by Step Explanation:

The cost of equity can be find using the dividend growth model.

The cost of equity is:

Ke = D * (1+g) / p + g

[$2.41 (1.05) / $45] + 0.05

= ($2.5305/$45) + 0.05

=0.0562 + 0.05

=0.1062 or 10.62%

Therefore the company's cost of equity is 0.1062 or 10.62%

Cost of equity = 10.6%

Explanation:

The value of a stock using the dividend valuation model, is the present value of the expected future dividends discounted at the required rate of return. The required rate of return is the cost of equity

The model is represented below:

P = D * (1+g) / ke - g

Ke - cost of equity, g - growth rate, p - price of the stock

This model can used to work out the cost of equity, as follows:

Ke = D * (1+g) / p + g

D - 2.41, g - 5%, - p - 45

Ke = 2.41 * (1.05) / 45 + 0.05

Ke = 0.10623 * 100 (we convert to percentage by multiplying by 100)

Ke = 10.6%

Cost of equity = 10.6%