Gremlin Industries will pay a dividend of $ 1.55 per share this year. It is expected that this dividend will grow by 7 % per year each year in the future. The current price of Gremlin's stock is $ 22.10 per share. What is Gremlin's equity cost of capital?

Cost of capital for Gremlins is 14.01%

Explanation:

The DDM is used to value a stock by discounting the future dividends with the required return hence it will be used to calculate the required return / cost of equity

SP = D1 / r - g

SP $22.10, D1 $1.55, g 7% plug in the values

22.10 = 1.55 / r - 0.07

22.10 (r - 0.07) = 1.55

22.10 (r - 0.07) / 22.10 = 1.55/22.10

r - 0.07 = 1.55/2.10

r = 1.55/22.10 + 0.07

=0.1401

=14.01%

Answer: 14%

Explanation:

We can calculate this using the Gordon Growth Model which looks like this,

P = D1 / r - g

P is the current stock price

D1 is the next dividend

r is the rate of return or the cost of capital

g is the growth rate.

We have all those figures except the cost of capital so making r the subject of the formula we can solve for it. Doing that will make the formula,

r = D / P + g

r = 1.55 / 22.10 + 0.07

r = 0.1401

r = 14%

14% is the equity cost of capital.

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