Question

Reliable Electric is a regulated public utility, and it is expected to provide steady dividend growth of 2% per year for the indefinite future. Its last dividend was $6 per share; the stock sold for $60 per share just after the dividend was paid. What is the company’s percentage cost of equity? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Answer 1

Solution:

The price of a share of stock is calculated using the following formula :

P₀ = D₀ * [ ( 1 + g ) ] / ( k_e – g )

Where

P₀ = Price of the share ; D₀ = Dividend paid in Year 0 i.e., Last dividend paid ; g = growth rate ;

k_e = Cost of equity   ;

As per the information given in the question we have ;

D₀ = $ 6.00 ;       g = 2 % = 0.02 ; P₀ = $ 60.00 ;   k_e = To find   ;

Applying the above values in the formula we have

60 = [ 6 * ( 1 + 0.02 ) ] / ( k_e – 0.02 )                         

60 = [ 6 * 1.02 ] / ( k_e – 0.02 )

60 = 6.12 / ( k_e – 0.02 )

60 * ( k_e – 0.02 ) = 6.12                                             

k_e – 0.02 = 6.12 / 60

k_e – 0.02 = 0.1020

k_e = 0.02 + 0.1020 = 0.1220

k_e = 12.20 %

Thus the cost of equity is = 12.20 %