A firm has common stock with a market price of $55 per share and an expected dividend of $2.81 per share at the end of the coming year. The dividends paid on the outstanding stock over the past five years are as follows: The cost of the firm's common stock equity is
A) 4.1 percent.
B) 5.1 percent.
C) 12.1 percent.
D) 15.4 percent.

Question

A firm has common stock with a market price of $55 per share and an expected dividend of $2.81 per share at the end of the coming year. The dividends paid on the outstanding stock over the past five years are as follows:  The cost of the firm's common stock equity is
A) 4.1 percent. 
B) 5.1 percent. 
C) 12.1 percent. 
D) 15.4 percent.

Quizplus · Accepted Answer

To calculate the cost of common stock equity, we use the dividend growth model. 
Cost of Common Stock Equity = (Expected Dividend / Current Market Price) + Dividend Growth Rate

Expected dividend = $2.81
Current market price = $55

To find dividend growth rate, we need to calculate the annual dividends growth rate over the past 5 years.

Dividend growth rate = [(2.25/1.75) * (2/2.25) * (2.50/2) * (2.75/2.50) * (2.81/2.75)]^(1/5) - 1 
Dividend growth rate = 0.0626 or approximately 6.26 %

Therefore, Cost of Common Stock Equity = (2.81/55) + 0.0626 = 0.051 or approximately 5.1%

Hence, the answer is C.

A Firm Has Common Stock with a Market Price of $55