The Dedus Shoes, Inc. has common shares with a price of $28.76 per share. The firm paid a dividend of $1.00 yesterday, and dividends are expected to grow at 10 percent for two years and then at 5 percent, thereafter. What is the implied cost of common equity capital for Dedus? Round your final percentage answer to 1 decimal place.

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Quizplus · Accepted Answer

The implied cost of common equity capital for Dedus can be calculated using the Dividend Discount Model (DDM) for a stock with dividends growing at different rates. The formula for the price of a stock with a two-stage growth model is:$$ P_0 = \frac{D_1}{(1 + r)^1} + \frac{D_2}{(1 + r)^2} + \frac{D_3}{(r - g_2)(1 + r)^2} $$Given:- $ P_0 = $28.76 $ (current stock price)- $ D_0 = $1.00 $ (dividend paid yesterday)- Growth rates: 10% for two years ($ g_1 = 10\% $) and then 5% indefinitely ($ g_2 = 5\% $)- $ D_1 = D_0 \times (1 + g_1) = $1.00 \times (1 + 0.10) = $1.10 $- $ D_2 = D_1 \times (1 + g_1) = $1.10 \times (1 + 0.10) = $1.21 $- $ D_3 = D_2 \times (1 + g_2) = $1.21 \times (1 + 0.05) = $1.27105 $Plugging these into the formula and solving for $ r $ (the cost of equity) involves iterative calculation or financial calculator, aiming to match the present value of these cash flows to the current stock price. Through calculation or using a financial calculator, you find that the rate $ r $ that equates the present value of these expected dividends to the current stock price is approximately 9.0%. This rate is the implied cost of common equity capital for Dedus.