Gangland Water Guns, Inc. is expected to pay a dividend of $2.10 one year from today. If the firm's growth in dividends is expected to remain at a flat 3 percent forever, then what is the cost of equity capital for Gangland if the price of its common shares is currently $17.50

Given:

D1 = $2.10

Po = $17.50

g = 3 %

Po = D1 / (r - g)

Where,

Po = current stock price

D1 = dividend paid per year

r = rate of returns

= cost of equity

g = rate of growth of dividend

r = (D1 + (g * Po)) / Po

Inputting their values,

r = (2.10 + (0.03 * 17.5)) / 17.5

= 0.15

= 15%

15%

Explanation:

we can use the Gordon growth model to determine the required rate of return:

current stock price = future dividend / (required rate of return - growth rate)

$17.50 = $2.10 / (required rate of return - 3%)

required rate of return - 3% = $2.10 / $17.50 = 0.12 = 12%

required rate of return = 12% + 3% = 15%