Will Co. is expected to pay a dividend of $2 per share at the end of year 1(Div₁), and the dividends are expected to grow at a constant rate of 4 percent forever. If the current price of the stock is $20 per share, calculate the expected return or the cost of equity capital for the firm. A)10 percent B)4 percent C)14 percent D)20 percent

Question

Quizplus · Accepted Answer

The dividend discount model can be used to calculate the expected return or cost of equity capital for the firm. Using the model, we can calculate the expected dividend in year 2 as follows: DivS2 = DivS1 x (1+g) = $2 x (1+0.04) = $2.08. 
Using this information, the cost of equity can be calculated as follows: 
Ke = (DivS1 + DivS2) / Price + g = ($2 + $2.08) / $20 + 0.04 = 0.14 or 14%. Therefore, the expected return or the cost of equity capital for the firm is 14 percent.

Will Co Is Expected to Pay a Dividend of $2 Per