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 gL = 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 dividend growth model, 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

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