The CEO of Harding Media Inc.as asked you to help estimate its cost of common equity.You have obtained the following data: D₀ = $0.85; P₀ = $22.00; and g = 6.00% (constant).The CEO thinks,however,that the stock price is temporarily depressed,and that it will soon rise to $40.00.Based on the DCF approach,by how much would the cost of common from reinvested earnings change if the stock price changes as the CEO expects?

Question

Quizplus · Accepted Answer

$\begin{array}{lrr}
 & \text { Old Price } & \text { New Price } \
\mathrm{D}_{0}& \$ 0.85 & \$ 0.85 \
\mathrm{P}_{0} & \$ 22.00 & \$ 40.00 \
\mathrm{~g} & 6.00 \% & 6.00 \% \
\mathrm{D}_{1}=\mathrm{D}_{0} \times(1+\mathrm{g}) & \$ 0.901 & \$ 0.901 \
\mathrm{r}_{\mathrm{s}}=\mathrm{D}_{1} / \mathrm{P}_{0}+\mathrm{g} & 10.10 \% & 8.25 \%\
 \mathrm{Difference,r}_{s0}-\mathrm{r}_{s1} & - 1.84 \% 
\end{array}$