Answer:
Please find the detailed answer as follows:
Explanation:
According to the given problem,
Today’sshare price(Po ) = $22
Dividend ofthis year( Do ) = $0.88
Growth rate(g)= 7.7% {since the share price has increased from $22 to $23.54 thegrowth rate is 7.7%}
Calculation of Dividend yield: It is calculated bydividing annual dividend per share by Stock price pe share.
Dividend yield = Annual dividend per share/Stock price pershare
= $0.88/22
= 0.04 or 4%
Calculation of Equity cost of capital: The return thatthe shareholders require on the stock, can be interpreted asfirm’s cost of equity capital. It is denoted withRE. It is calculated as
RE = (D1/Po )+ g
Where D1 is the expected dividend for next year
{D1 = Do X (1+g)= $0.88(1+0.077) =$0.88(1.077) = $0.94}
Po is today’s share price
G is the constant growth rate
Now, substituting the above values in the formula, weget
RE = ($0.94/22) + 0.077
= $0.0427 + 0.077
= 0.1197 or 11.97%
The cost of equity is thus 11.97%
