An all-equity firm produced a dividend flow of $20,000 last year.The market value of the firm is $650,000 and the dividend is expected to increase at 4% each year.What is the cost of equity capital for this firm?
A)5.5%
B)6.2%
C)7.2%
D)7.8%
E)8.1%

Question

Quizplus · Accepted Answer

Using the Gordon Growth Model, we can calculate the cost of equity capital:
r = (D1 / P0) + g
Where:
D1 = expected dividend for next year = D0(1+g) = $20,800
P0 = market value of the firm = $650,000
g = dividend growth rate = 4%
r = cost of equity capital

Putting in the numbers, we get:
r = ($20,800 / $650,000) + 4% = 7.2%

Therefore, the answer is choice C) 7.2%.

An All-Equity Firm Produced a Dividend Flow of $20,000 Last