A firm’s most recent annual dividend was $2 per share; its shares sell

A firm’s most recent annual dividend was $2 per share; its shares sell for $40 in the stock market, and the company expects its dividend to grow at a constant rate of 5% in the foreseeable future.

Using the dividend growth (Gordon) model, what would you estimate its equity cost of capital to be?

ANSWER

10.25% = [(2 )(1.05 )/(40 + .05 )]