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20 July, 05:04

2. The Muse Company just issued a dividend of $2.75 per share on its common stock. The company will maintain a 5.8% dividend growth indefinitely. The stock is selling for $59.00 per share. What is the company's cost of equity?

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  1. 20 July, 06:01
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    The cost of equity is 10.73%

    Explanation:

    The cost of equity or required rate of return is the return that investors expect from the stock based on the stock's risk. The company pays a dividend that will grow constantly, so the constant growth model of DDM will be used. The formula for price using constant growth model is,

    Price = D0 * (1+g) / r - g

    Where,

    D0 * (1+g) is the D1 or the dividend expected for the next period r is the cost of equity g is the growth rate in dividends

    Thus,

    59 = 2.75 * (1+0.058) / (r - 0.058)

    59 * (r - 0.058) = 2.9095

    59r - 3.422 = 2.9095

    59r = 2.9095 + 3.422

    r = (2.9095 + 3.422) / 59

    r = 0.1073 or 10.73%
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