Corporate Finance Q98

98Using the dividend discount model, the cost of equity capital for a company which will pay a dividend of $2.00 next year, has a payout ratio of 35 percent, a return on equity (ROE) of 15 percent, and current stock price of $40, is:

Option : C
Explanation : Using the sustainable growth calculation, the growth rate is calculated as:
g = (1 – Dividend payout ratio) (Return on Equity)
= (1 – 0.35) (15%) = 9.8%
Re = (D1 / P0) + g = ($2.00 / $40) + 9.80% = 14.75%.

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