Question

The Global Advertising Company has a marginal tax rate of 40 percent. The last dividend paid by Global was $0.90. Global's common stock is selling for $8.59 per share, and its expected growth rate in earnings and dividends is 5 percent. What is Global's cost of common stock?

(A) 12.22%
(B) 17.22%
(C) 10.33%
(D) 9.66%
(E) 16.00%

Answer 1

Answer:

The correct answer is E: 16%

Explanation:

The cost of common stock is a common stockholders’ required rate of return. There are 3 methods to calculate the cost of common stock:

i- Dividend discount model or DMM

ii- Capital asset pricing model or CAPM

iii- Bond yield plus risk premium approach

Because of the information provided by the exercise, the correct method to use is de Dividend discount model.

Knowing the current market price of a stock and the last dividend paid, we can calculate the required rate of return, which is equal to the cost of common stock.

rs=(D1/P0)+g

D1= expected dividend

P0= current market price of the stock

g= dividend’s growth rate

To calculate D1 you need to use the following formula= D0x(1+g)

Using the exercise information:

D1=D0*(1+g)=0.90*1,05=0.945

P0=8.59

g=0,05

rs=(0.945/8.59)+0,05=0,16*100=16%