Will Co. is expected to pay a dividend of $2 per share at the end of year -1(D1) and the dividends are expected to grow at a constant rate of 4% forever. If the current price of the stock is $20 per share calculate the expected return or the cost of equity capital for the firm.
A) 10%
B) 4%
C) 14%
D) None of the above.

Question

Quizplus · Accepted Answer

The expected return or cost of equity capital (r) can be calculated using the Gordon Growth Model as follows:

r = (D1 / P0) + g

where, 
D1 = Dividend at the end of year 1 = $2
P0 = Current price of the stock = $20
g = growth rate of dividends = 4%

Substituting the values, we get:

r = (2 / 20) + 0.04
r = 0.1 or 10%

Therefore, the expected return or cost of equity capital for the firm is 10%. Option C is the correct answer.

Will Co Is Expected to Pay a Dividend of $2 Per