Verigreen Lawn Care products just paid a dividend of $1.85.This dividend is expected to grow at a constant rate of 3% per year,so the next expected dividend is $1.90.The stock price is currently $12.50.New stock can be sold at this price subject to flotation costs of 15%.The company's marginal tax rate is 40%.Compute the cost of common equity.

Question

Quizplus · Accepted Answer

The cost of common equity can be calculated using the Gordon Growth Model (Dividend Discount Model): Cost of Equity = (D1 / P0) + g, where D1 is the next expected dividend ($1.90), P0 is the net price after flotation costs ($12.50 * (1 - 0.15) = $10.625), and g is the growth rate (3%). Thus, Cost of Equity = ($1.90 / $10.625) + 0.03 = 0.179 + 0.03 = 0.182 or 18.2%.

Verigreen Lawn Care Products Just Paid a Dividend of $1