Suppose Stark Ltd. just issued a dividend of $1.73 per share on its common stock. The company paid dividends of $1.40, $1.47, $1.54, and $1.65 per share in the last four years. If the stock currently sells for $60, what is your best estimate of the company's cost of equity capital using the arithmetic average growth rate in dividends?

Cost of equity = 8.44%

Explanation:

The price of a share can be calculated using the dividend valuation model

According to this model the value of share is equal to the sum of the present values of its future cash dividends discounted at the required rate of return.

The model can be modified to determine the cost of equity

Ke = Do (1+g) / P + g

g - growth rate in dividend, P - current price, D - recent dividend

growth rate = ((Recent dividend / oldest dividend) ^1/n - 1) * 100

n - no of years of growth

growth rate = (1.73/1.40) ^1/4 - 1 * 100 = 5.4%

Cost of equity = 1.73 * (1.054) / 60 + 0.054 = 8.44%