Question

Castillo Corporation common stock is currently priced at $39.75 per share. The company just paid $4.35 per share as its annual dividend. The dividends have been increasing by 7.5 percent annually and are expected to continue doing the same. What is the cost of equity

Answer 1

The cost of equity is 19.5%, this is the return that the shareholders will receive on their investment in the company.

What is the meaning of cost of equity?

The cost of equity are the return a company in theory pays to its equity investors, i.e., shareholders, in order to compensate for the risks they incur in investing in their investments.

Dividend paid, D0 = $4.35 per share

Current selling price = $39.75 per share

Dividend growth rate = 7.5% = 0.075

Now,

$\rm\,Cost \,of\, equity\, = [ \frac{ [ ( D0 \times (1 + g) )}{39.75} ] + 0.075\\\\= [(\dfrac{4.35 \times (1 + 0.075)}{39.75})] + 0.075 \\\\= [\dfrac{4.67}{39.75}] + 0.075\\\\= 0.12+ 0.075\\\\= 0.195\times 100\\\\= 19.5\%$

Hence, The correct answer is 19.5%

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