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Basic Question 6 of 12
Suppose a firm is expected to pay a dividend of $2.10 per share in one year. This dividend, along with firm earnings, etc., is expected to grow at a rate of 5% forever. If the current market price for a share of the firm is $38.62, what is the cost of equity?
B. 11.22%
C. 6.00%.
A. 10.44%
B. 11.22%
C. 6.00%.
User Contributed Comments 12
| User | Comment |
|---|---|
| cgeek | 2.1 / 38.62 + 5% = 10.44 % |
| sarath | Here 2.1 is the D1 expected dividend at the end of one periord... |
| ljamieson | cost of equity <=> exp'd return? |
| carnival | yes. |
| chamad | In other words we have to resolve for the required rate of return(k) |
| Mavizo | Sarath, does it mean that the fact that 2.1 is the expected dividend it has already taken into consideration (1 + g)? |
| kutta2102 | Mavizo: Yes, if the expected dividend is given, the 1+g is already taken into consideration. Remember that the DDM formula is the present value of all future dividends. Therefore the first dividend that will be discounted is D1 which is equal to D0(1+g) |
| tochiejehu | use the constant growth model and make the required return subject of formular |
| khalifa92 | it will pay dividend in one year so it is D(1+g) |
| workinehg | Great explanation kutta2102 |
| b25331 | P0 = D1 / (r-g) 38.62 = 2.1 / (r - 0.05) -> solve for r r = 10.44% |
| MathLoser | These questions are too eazy I can solve it with my eyes closed. |
I am using your study notes and I know of at least 5 other friends of mine who used it and passed the exam last Dec. Keep up your great work!
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Learning Outcome Statements
calculate the value of a common stock using the Gordon growth model and explain the model's underlying assumptions;
calculate the value of non-callable fixed-rate perpetual preferred stock;
calculate and interpret the implied growth rate of dividends using the Gordon growth model and current stock price;
describe strengths and limitations of the Gordon growth model and justify its selection to value a company's common shares;
CFA® 2025 Level II Curriculum, Volume 3, Module 21.