Individual or component costs of capital Compute the cost of

(Individual or component costs of capital) Compute the cost of capital for the firm for the following:

A new common stock issue that paid a $1.77 dividend last year. The firm\'s dividends are expected to continue to grow at 8.4 percent per year, forever. The price of the firm\'s common stock is now $27.61.

Solution

Solution: Cost of capital = 15.35% Working Notes: Using Gordon growth model : P0 = D1 / (Ke - g), where D1 = D0(1+g) ke = cost of Equity/ Capital Po=current share price = $27.61 per share g= growth rate= 8.40% = 0.084 D0= Current Dividend=$1.77 per share P0 = D0(1+g)/(Ke -g) Ke=(D0(1+g)/P0) + g =(1.77(1+0.084)/27.61) + 0.084 =0.153492213 =0.1535 =15.35% Notes: Since the firm is all equity firm there is debt , hence cost of equity is cost of capital for the firm. Please feel free to ask if anything about above solution in comment section of the question.