The common stock of a ﬁrm is currently priced at $53 a share. The company paid $1.40 in common dividends last year and expects to increase this amount by 3% annually. The stock has a beta of
1)40, which is about equal to its industry average. Given this information, what is the cost of equity
ﬁnancing?

Question

Quizplus · Accepted Answer

Using the dividend growth model, we can calculate the cost of equity financing as follows:

Ke = (D1 / P0) + g

Where:
D1 = Expected dividend next year
P0 = Current stock price
g = Expected dividend growth rate

D1 can be calculated as follows: 
D1 = D0 * (1 + g) 
D1 = 1.40 * (1 + 0.03) 
D1 = 1.442

Ke = (1.442 / 53) + 0.03 
Ke = 0.0272 + 0.03 
Ke = 0.0572 or 5.72%

Therefore, the cost of equity financing is 5.72%, which corresponds to choice (C).

The Common Stock of a ﬁRm Is Currently Priced at $53