The cost of equity: Oasis, Inc., has common shares with a price of $21.12 per share. The firm is expected to pay a dividend of $1.75 one year from today, and dividends are expected to grow at 10 percent for two years after that and then at 5 percent thereafter. What is the implied cost of common equity capital for Oasis?

Question

Quizplus · Accepted Answer

Using the dividend discount model: 
D1 = $1.75
g1 = 10%
g2 = 10%
g3 = 5%
P0 = $21.12
Using the formula: P0 = D1/(r-g1) + D2/(1+r)^2 + D3/(1+r)^3 + ... + Dn(1+g)^n/(r-gn)
where n = infinity
Plug in the numbers: 
$21.12 = $1.75/(r-0.1) + $1.75(1.1)/(1+r)^2 + $1.75(1.1)^2/(1+r)^3 + ... 
Solving for r using a financial calculator or trial and error, we get r = 14%, therefore the implied cost of common equity capital for Oasis is 14%.

The Cost of Equity: Oasis, Inc