S.Bouchard and Company hired you as a consultant to help estimate its cost of capital.You have obtained the following data: D₀ = $0.85;P₀ = $22.00;and g = 6.00% (constant).The CEO thinks,however,that the stock price is temporarily depressed,and that it will soon rise to $37.00.Based on the DCF approach,by how much would the cost of equity from retained earnings change if the stock price changes as the CEO expects? Do not round your intermediate calculations.

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Quizplus · Accepted Answer

The cost of equity using the DCF approach is calculated as: Cost of Equity = (D1/P0) + g, where D1 = D0 * (1 + g). Initially, D1 = $0.85 * 1.06 = $0.901. With P0 = $22, the initial cost of equity = ($0.901/$22) + 0.06 = 0.04095 + 0.06 = 0.10095 or 10.095%. If the stock price rises to $37, the new cost of equity = ($0.901/$37) + 0.06 = 0.02435 + 0.06 = 0.08435 or 8.435%. The change in cost of equity = 8.435% - 10.095% = -1.66%.

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