1. A firm has a common stock with a market price $55 per share and an

QUESTION

1. A firm has a common stock with a market price $55 per share and an expected dividend of $2.81 per share at the end of the coming year. The dividends paid on the outstanding stock over the past five years are as follows:Year Dividend1 $2.002 $2.143 $2.294 $2.455 $2.62The cost of the firms common ¦
Market Price per share= $55 Year 1 (Dividend) = $2 Year 2 (Dividend) = $2.14 Year 3 (Dividend) = $2.29 Year 4 (Dividend) = $2.45 Year 5 (Dividend) = $2.62 Expected dividend (for 6th year)= $2.81 Growth rate for the 6th year= [(2.81/2.62)-1]*100= 7.25% So, Price per share= Dividend1/ (1+ required rate of return) + Dividend2/ (1+ required rate of return) ^2 + Dividend3/ (1+ required rate of return) ^3 + Dividend4/ (1+ required rate of return) ^4 + Dividend5/ (1+ required rate of return) ^5+ Dividend6 (Expected dividend)/ (required rate of return- growth)*1/(1+ required rate of return)^5 => 55= 2/ (1+r) + 2.14/ (1+r) ^2 + 2.29/ (1+r) ^3 + 2.45/ (1+r) ^4 +¦

2.62/ (1+r) ^5 + [(2.81/r-0.0725)* 1/ (1+r) ^ 5] Let us suppose r = 10% $55= $1.82 + $1.77 + $1.72 + $1.67 + $1.63 + $63.44 $55= $72.05 Let us suppose r= 15% $55= $1.74 + $1.62 + $1.51 + $1.40 + $1.30 + $18.03= 25.60 So interpolating the results we get, (r-10)%/ (15-10)% = (55-72.05)/ (25.60-72.05) Or, (r-10) %= 5%* (-17.05/ -46.45) Or, r= 10%+ 5%*0.37= 10+ 1.85= 11.85% (approx) Hence, the cost of firms capital is 11.85% (approx).

ANSWER:

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